The Internal Revenue Service requires that all income be reported in a tax return, and failure to do so can result in monetary penalties and sometimes, criminal penalties. However, most penalties can be waived if you can convince the IRS that you had reasonable cause for not reporting the income and didn't understand that you needed to report that income on your return. Criminal penalties are only for people who fail to report income and know that they are hiding something.
TL;DR (Too Long; Didn't Read)
If you have not reported your income to the IRS or are intentionally misreporting your income, you could be charged with a variety of crimes or face severe fiscal penalties.
Tax Return Accuracy
Your tax returns must be accurate, meaning that they must reflect all the money you made during the tax year that you were required by law to report. Workers who earn tips are required to report all tips to their employer. Unreported tips may cause you to incur a 50 percent penalty on the required Social Security, Medicare and railroad retirement taxes, since your employer was unable to withhold the required amount. The IRS tacks on an accuracy penalty of 20 percent if you underpay your tax by not reporting income. You might face the accuracy penalty for any of the following reasons: you are negligent or disregard IRS rules; you "substantially" underpay your tax; you claim tax benefits for a false transaction; or you fail to disclose a foreign asset.
Understanding Tax Fraud
Not reporting your income could result in the IRS tacking on a fraud penalty. The fraud penalty is 15 percent for each part of a month that your tax was late due to fraud, with a maximum of 75 percent. There is a second fraud penalty of 75 percent for substantially underpaying your tax due to fraud. There is also a $5,000 penalty if the IRS determines you've submitted a frivolous tax return containing substantially unreported income.
Penalty for Missed Payments Due to Failure to Report
Failure to report income to the IRS will also result in penalties, as essentially you have missed a payment and face a late-payment penalty. The IRS levies a failure-to-file penalty of 5 percent for each part of a month that a return is late, with a maximum of 25 percent. After the return is 60 days late, there is a penalty: the lesser of $135 and the unpaid tax. The IRS also charges a failure-to-pay penalty of 0.5 percent of your unpaid tax for each portion of a month the tax goes unpaid.
Interest on Unpaid Taxes
Interest is charged on all tax not paid by the due date. It is also charged if you get an extension. Certain penalties, including those for failure to file, accuracy, and fraud, accrue interest from the date the tax was due. Other penalties don't accrue interest until you receive a notice from the IRS.
Other Criminal Penalties
An intentional failure to report income to the IRS can result in penalties worse than mere fines; the IRS may come after you for criminal penalties. The IRS typically goes after filers for tax evasion, intentionally not filing a return, intentionally filing incorrect information, intentionally not paying the correct amount of tax, making a fraudulent statement and preparing a fraudulent return. If the IRS conducts a criminal investigation based upon fraudulent activity, the accused could face jail time of up to five years and fines of up to $250,000 depending upon the charges.