In a world full of debt, the largest bill is the government s. To raise revenue and make their payments, they impose taxes on people in multiple ways. Although no one is ecstatic about paying taxes, it is not a choice. However, how you report your income and taxes is a choice.
There are many ways to get out of paying taxes, some are legal and some are illegal. The legal ways, using the tax laws, to avoid taxes are called tax avoidance and the illegal ways are called tax evasion (Burns, Jones, Kulsrud, Oestreich, Pratt, Schnee, Thompson, Tripp, Tucker, Vogel 1160).
Balter defines tax evasion as willfully paying less tax than known to be legally due (2. 3).
The focus of this paper is how the government determines if a situation is tax evasion, punishment for these crimes, the different types of tax evasion, the causes, the effects of them and possible ways to prevent these cases. The way the government determines if a case is, in fact, an evasion of taxes, is by following three basic elements set out in code section 7201.
First, the tax must be due and owed for the year. Secondly, there must be proof that unlawful activity is involved. Finally, it must be the intent of the taxpayer to evade taxes (Balter 11. 26).
Section 7201 of the tax code also discusses the legal ramifications of this unlawful act.
It states that anyone that evades taxes has indeed committed a felony. They can be fined up to $100, 000 and imprisoned up to five years. Since corporations cannot be imprisoned, their fine increases up to a maximum of $500, 000. In addition to these obligations, any underpayment due to fraud used to be penalized fifty percent of the underpayment (Bittker and Stone 950).
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This penalty is still imposed, but the amount has increased to seventy-five percent of the underpayment according to code section 6653 (b).
In some more recent cases of tax evasion, new types of sentences were imposed on the evaders. Some offender even had to make public speeches about the crimes they committed. This is one method that seems to have a positive effect in deterring offenders or repeat offenders from committing evasion (Simon and Witte 112).
There are many different outlets that people use to evade taxes. They range anywhere from tax on interest income to tax on illegal income.
There never has been a large quantity of income lost from tax on interest and dividend income, but for a short period of time, it was rising each year until the IRS started matching payer reports with the individual returns. Now, income lost on these items is very low, but there are still some types of interest that go unreported and the IRS has no paper trail to follow them. These items are interest on bearer securities and interest on informal loans between people (15).
Investment income often goes unreported also. There are two types of investments, investments within the United States and investments abroad.
Despite the risks involved in foreign investments, people tend to commit more abroad. This is due, in part, to the ease of evading taxes on such investments. People have found that if they emigrate to other countries with lower taxes on capital taxation, they can pay tax there and legally evade the tax in the United States (Mering 201).
Another way people have been evading taxes is through bartering. Due to many exchanges with foreign countries, it is easy to keep the transactions from the eyes of the IRS. In fact, returns that include barter exchanges are twice as likely to need tax adjustments than other returns (Simon and Witte 19).
Bartering is one of the fastest growing areas in the underground economy. Foreign bartering is not the only type that taxes have been evaded through. Simple bartering between people can consist of baby-sitting or even an exchange of professional services (AICPA 20).
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The underground economy is definitely a major resource for tax evasion. The transactions are not subject to withholding or any type of informational reporting. It is also more likely that the exchanges will be cash because checks are traceable.
Some underground activities include skimming, tips, domestic help, moonlighting jobs, business travel, odd jobs while excepting unemployment and social security, income paid to a foreign bank account, garage sales or flea markets and sales of arts and crafts by the maker (AICPA 18-19).
Even though many of these items do not seem like major crimes, chunks of revenue to the government are lost due to the lack of taxation because they go unreported. One major underground issue has been prostitution. Many people have pushed for its legalization because there are many benefits from doing so. This way prostitution could be monitored for drug use and diseases. Also, the IRS would have the capability to track and tax the income from it.
This does, however, present a moral dispute (Simon and Witte 281-282).
Another issue in tax evasion is custom and excise taxes or evil duties. These taxes are direct taxes and advocate certain ethical ideas (Seligman 367).
One way people avoid some of these taxes is by understating certain dimensions or numbers of units. Usually a physical check is needed, but it is very time consuming. Due to this, many people escape without a trace of evidence that they have evaded some of these excise taxes.
Another way to evade these taxes is through smuggling. In fact, it is the main source of escape from excise taxes (Due 49).
One area of goods smuggled in is cigarettes. It has been a problem for decades. It grew from the early 1950 s and then maximized in the 1960 s (Simon and Witte 33).
It has not been a major problem for many years, but may become one due to the enforcement of the legal age to buy cigarettes.
One example of an operation an individual can take to smuggle cigarettes is to rent a truck, drive to a lower tax state and purchase cigarettes from a wholesaler or retailer. Then, once the individual drives back, he can sell the cigarettes to another wholesaler or retailer and make a profit off the difference in taxes. The individual can expect to earn as much as $5000 a truckload for a truck that holds one ton (38).
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The other productive excise taxes for the government are on alcohol and gasoline.
The government does not focus so much on these taxes though because they do not provide a major source of revenue. Most evasion of these taxes come from people further down the distribution system like, wholesalers, retailers and consumers. There have not been as many problems in the area of alcohol recently due to the lowering of the drinking age (32).
However, many people are disgruntled because gasoline prices have been shooting up. Illegal gambling is another underground activity causing concern. It, too, is one major cost for the government.
Not only do they lose the revenue from the gambling excise tax, but they also have to put enforcement programs into place. People like to gamble illegally because none of the income is taxed, but they do risk other ramifications than those issued for tax evasion. Since the gambling is illegal, there is a possibility they will be arrested, fined or imprisoned (222).
Illegal gambling also has a social cost because it can lead to police corruption (223).
A different area of focus on tax evasion is evasion of the sales tax. Sales taxes can be avoided in many different ways.
Some sources are smuggling, firms failure to register and pay taxes, under reporting of gross sales, recording taxable sales as exempt sales and misclassification of goods into lower rate classes. One major obstacle in enforcing this tax is money being passed under the table to the tax inspectors to overlook certain transactions. It is not as prominent a problem in the United States as it is in underdeveloped countries, but to some extent, it is a problem in all countries (Due 160-162).
There are several contributing factors to why people commit tax evasion. One is high tax rates combined with a high rate of inflation.
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When people find themselves with less income and a higher tax bill, they are not happy. They start to feel that they are paying more than their share of taxes and then turn to illegal measures to reduce their taxes. Another contributing factor in tax evasion is the increased complexity of tax law over the years. Individuals find it difficult to comprehend the laws and their changes. This lack of understanding makes them feel like everyone is being treated differently and others are benefiting from it.
Individuals begin to believe others have an unfair advantage over them. In turn, they tend to rationalize cutting corners to escape taxes. A similar factor is the use of the Internal Revenue Code. The government uses the code to interfere with certain social and economic activities. Congress sets up certain incentives, but they cannot be taken advantage of by all people, so many individuals feel cheated. Again people cut corners on their taxes and rationalize why they choose to cheat the government.
With the growing problem of tax evasion, the media has opted to focus and bring the problem out into the open. Although this seems like a great plan, the publicity is having the opposite effect of what was intended. Instead of scaring people out of tax evasion, it gives them an incentive to evade taxes. People form the opinion that everyone else is doing it so why shouldn t I. Even though it seems most of the public has attempted to evade taxes, many taxpayers do not fully understand exactly what they are getting themselves into. Many do not even realize that income earned illegally is still taxable.
They also do not know exactly what would happen to them if they were found evading taxes. Lastly, individuals do not realize the total effect tax evasion can have on society. Not only is society changing for the above stated reasons, but in many other ways. People s morals are adjusting to this new society. They no longer have faith in church, state, education and other major factors in life. Instead of feeling that the law is enforceable in all walks of life, they choose to ignore the laws that seem to be unfair.
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This does not exclude the tax laws. In fact, this lack of faith in government causes many problems. The government has been inefficient with taxpayer money and people use this as a justification to report less income. They also feel that too many new rules have been put in place along with payroll taxes, so employers tend to keep some employees off the books (AICPA 23-24, 43).
Along with all of these reasons to evade taxes, come consequences. Tax evasion has two major costs in effect; the government costs and social costs.
The government s cost is made up of a loss of revenue and a cost to put compliance programs into place. To show a rough estimate of what these costs are, let us take a look at the costs in 1976. The government s loss of revenue was between $18 and $22 billion dollars with an added $1 billion dollars in compliance costs. Today s problem exceeds these amounts simply due to inflation and the growing trend of tax evasion. So, it is easy to see why the government places such importance on catching tax evaders (Simon and Witte 20).
As tax rates increase, unreported income increases even more rapidly (18).
Social costs are not as easy to estimate and can be even greater than the government s costs. Socially, tax evasion causes a type of transfer tax. When people evade taxes, the government needs to compensate for their loss of revenue.
This pushes the tax onto the individuals that do pay their taxes. They either have to pay a higher tax or go without certain services that would have been provided had there been no tax evasion involved (20).
Now, to add to these costs, their money goes towards the prosecution of the tax evaders (261).
The benefit of course would be to the tax evaders who have increased their wealth, but this leads back to the issue of change in morals and ethics taking place in society (17).
The government has tried many programs and put a lot of money into compliance of tax laws.
Some possible solutions and programs already taking place are audits, disintegration of tax exemptions, better enforcement, lowering of the tax rates and other small changes in the system (Wang 109 and AICPA 30).
Audits tend to reveal a lot of information about the taxpayer. The IRS considers them to be the biggest factor contributing to compliance (Simon and Witte 18).
The initial meeting can have a great impact on how the audit will go. This is because most taxpayers are very cooperative except for those that have committed some type of evasion.
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If the taxpayer is uncooperative initially, the auditor will dig deeper because it appears they are hiding something. Even if they know the person evaded taxes, they still have to have visual proof before taking it a step further. In an audit, the auditor can come up with two conclusions. He can accept the return as is and approve it to be filed or he will find an adjustment necessary in favor of either the government or the taxpayer. In either case, they will attempt to make a deal. The individuals are required to sign a Form 870, which states that the deficit due to the IRS can be collected immediately.
If the adjustment is in favor of the taxpayer, signing this form says that they agree to the amount of the refund without any further a due (Bittker and Stone 913-914).
Without having to put so much force into the system, an easy way to motivate compliance would simply be to diminish some of the tax exemptions. This would keep the tax rate very broad, but at the same time would bring in more revenue. With a broad tax rate, compliance would increase simply due to more understanding of the tax laws. For example, if all sales were taxable, there would be no problems from vendors in applying the correct rates (Wang 109-110).
Along with audits and changes in the tax laws, there would be higher compliance if the government increased its enforcement activities.
Many people feel that high penalties are the largest deterrent for tax evaders. So, if the government enforces these penalties in all situations, compliance will go up. No amount of enforcement can be determined to alleviate the underground problems, but if the government can make a difference in these problems, they can produce as much as $20 of revenue for every dollar they spend. With stronger enforcement by the government, people will start to respect them again and that will account for some compliance (AICPA 31-32).
Other efforts to enforce compliance are simply by lowering the tax rates. With lower rates, people are less likely to cut corner on their taxes. Other changes within the system that should be made are the way lotteries are paid out. Over a certain amount of money, the States should be required to apply withholding. It should also be mandatory for people to report capital expenditures, like any additions to their homes. Prizes or incentives should not be allowed to be deductible unless they are included on the individual s 1099.
Lastly, certain questions should be added to the schedule C requiring information about any bartering or currency transactions (AICPA 43).
Even with all these preventative measures taking place, the government could never ensure full compliance. There are just too many people and too little time. Therefore, tax evasion continues to be a growing problem within society. It will continue to grow until society and government come together as a whole. Once they do come together, a positive movement will be put in place.
The government will receive higher compliance, the taxpayers will see this and respect the government again causing them to comply and so compliance will continue to increase. Right now, people s mentality are on a level where evading taxes is not a big deal because they are just one person and the taxes they evade don t make a difference; when in reality, all these one persons evading taxes causes a major deficit in governmental revenue. Bibliography AICPA. Under reported Taxable Income: The Problem and Possible Solutions.
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