Tax evasion covers more than the outright avoidance of making tax payments. It also refers to not filing a return when legally required to do so, and adjusting income amounts to avoid having to pay a certain amount of taxes. If qualified credits and deductions are taken, this is legal, and in fact remains the only legal method to reduce tax liability.
There are three main charges related to tax evasion, with punishments depending on the severity of the offense.
Tax Evasion: This felony conviction carries a sentence of up to 5 years in prison, with or without fines up to $100,000.
Filing a False Return: This felony conviction carries a sentence of up to 3 years in prison, with or without fines up to $100,000. For this conviction to occur, the IRS only has to prove the person filed false data and not that they intended to evade paying taxes. Be careful when filing!
Failing to File a Return: This misdemeanor conviction carries a sentence of up to 1 year in prison, with or without fines up to $25,000, for each year a return was not filed.
The IRS goes through returns the year they are filed, and even a few years back, for auditing. Though the vast majority of the U.S. population will never get audited, those who do must be able to show they claimed the correct amount of income, had the qualifications to take the credits and deductions that they did, and paid the appropriate funds if they were not due a refund.
So, if a return is not filed, how does the IRS know one should have been filed? The W-2's, 1099's and other tax forms sent out by January 31st each year always have a copy forwarded to the IRS, too. This way the IRS has a document to judge the returns that come in against. For instance, if a couple's W-2's reported $25,000 for income, but the couple only reported $17,000 income (before any credits and deductions) the W-2 would provide a red flag for the IRS to signal an audit. It appears from what was reported on the return versus the W-2, tax evasion is happening because the couple is not reporting $8,000 of income.
For freelancers, not all jobs will provide a 1099. Report all income, regardless of what is presented on the collection of 1099's, so if there is an audit, the IRS will find bank records match the return. This is the only way to show the IRS all income was claimed and taxes were filed and paid appropriately. If income is not claimed because there is no 1099 for it and the IRS decides to audit, they will want to see bank records to check for other income that should have been reported.