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How Tax Evasion Works

By: Dave Roos  | 

Gangster Al Capone sits in a train car on his way to serve a federal prison sentence for tax evasion, in October 1931. See more pictures of public enemies.
Hulton Archive/ Getty Images

Here's a little factoid that may provide you a little comfort as tax day approaches: According to the Internal Revenue Service (IRS), paying income tax in the United States is voluntary. Seriously? It's true, but before you run your 1040 through the shredder and go lead your neighbors in a confetti parade, let's define "voluntary." The official term is voluntary compliance, and it means that the U.S. government doesn't calculate your income tax for you and send you a bill. It is up to the individual to voluntarily and honestly comply with the U.S. tax code — all 4,500 pages of it.

And for the most part, the voluntary thing seems to work. According to the 2012 "Taxpayer Attitude Survey" conducted by the IRS, 73 percent of respondents "completely agree" that "it's every American's civic duty to pay their fair share of taxes," citing "personal integrity" as the greatest motivator, not the fear of an audit [source: IRS].

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Yes, voluntary compliance seems to work... for the most part. When answering the question, "How much, if any, do you think is an acceptable amount to cheat on taxes?" an impressive 87 percent of respondents to the IRS survey said "Not at all," but a disturbingly significant 4 percent said, "As much as possible" [source: I RS].

Any attempt by a taxpayer to knowingly cheat the system, either by underreporting income, exaggerating expenses, hiding money or failing to file a tax return, is called tax evasion. And tax evasion is big business.

Tax evasion creates something called the tax gap, which is the difference between the total revenue the IRS is owed in taxes and the amount it actually receives. For the 2011-2013 tax years (the most recent years for complete statistics, released in 2019), the tax gap was $441 billion a year on average. The voluntary compliance rate from 2011-2013 was 83.6 percent, which doesn't mean that 16.4 percent of Americans didn't pay their taxes. It means that American taxpayers as a whole underpaid their taxes by 16.4 percent [source: IRS]. Since federal income tax revenue helps pay for items on the federal budget — like defense and Social Security — that missing $441 billion equals 12.7 percent of the total 2013 federal budget.

So, who are these wily tax evaders and why isn't anyone stopping them? The fact is that the IRS doesn't have the manpower to catch every last tax cheat. There are fewer than 39,000 employees working in IRS tax enforcement (a 23 percent decline from 2010), and Americans filed around 169 million individual and corporate tax returns in 2020 [source: IRS]. That's 4,333 returns for each IRS agent. The result is that the IRS audits less than 1 percent of tax returns, leaving plenty of room for "error" [source: IRS].

Keep reading as we dig deeper into the different forms of tax evasion — underreporting, underpayment, money laundering, offshore accounts — and explain the difference between benign negligence and criminal tax fraud.