Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.
It’s one thing to make an innocent mistake on your taxes, or to overlook a tax break that could lower what you owe the IRS. While such innocent mistakes will still cost you, they usually won’t invoke the ire of the IRS to pursue criminal prosecution or assess a Civil Fraud Penalty.
When you intentionally disregard tax law, however, such willful neglect will get you in real trouble. The IRS defines “willfulness” as a voluntary, intentional violation of a known legal duty, specifically your tax filing and payment responsibilities.
Such intentional tax violations could lead to tough penalties on top of the unpaid tax and interest added to it. In some cases, the IRS pursues intentional violations as criminal acts that could carry jail time.
So it’s not a good idea to think even think about neglecting your tax filing duties or fudging the entries a little or a lot.
And in case you have any doubt as to what might be problematic, here are the top tax sins that could land you in very hot tax water.
1. Not reporting all your earned income
Failure to report all the money you make is a main reason folks end up facing an IRS auditor. When it comes to earned income — that’s your pay for work performed — not reporting payment generally isn’t an issue if all your money comes from wage or salary income. That amount is detailed on W-2 forms that must be attached to your Form 1040.
But if you’re an independent contractor, either as your full-time job or from side work in addition to your salaried position, it’s your responsibility to keep track of your earnings and let the IRS know the amount at tax time. When you’re paid more than $600 you should get a 1099-MISC from the client. And when your business accepts credit cards for payment, remember that each year your credit card merchant service provider will issue a 1099-K reflecting all the charge sales your business made. Don’t think of ignoring one of these forms. The IRS gets copies, too.
And even when you don’t get an earnings statement, it’s still your legal duty to report the income. Even without third-party tracking, the IRS will take a long look at your return if the numbers seem off.
2. Not reporting all your unearned income
Unearned income generally is investment income. In these cases, your banker, broker or the mutual funds that you bought directly will send you 1099-DIV or 1099-INT statements with your annual earnings. Again, don’t think you can “forget” to count one or more of these amounts. The IRS is copied on these statements, too.
3. Forgetting about foreign funds
Foreign financial accounts add another layer of complexity and potential costs if you fail to report them. The IRS has been on a mission for the last few years to halt hidden offshore accounts, significantly increasing its detection efforts and prosecuting owners of unreported accounts. And now starting with 2014 foreign banks are reporting interest and investment income to the IRS just like their domestic bank counterparts
The risk is even greater if you own a foreign financial account that must be disclosed under the Foreign Bank Account Report (FBAR) rules or the Foreign Account Tax Compliance Act (FATCA). A whole separate set of penalties applies here with a minimum amount of $10,000.00 per year per each account not disclosed.
4. Exaggerating deductions
Tax deductions are a great way to reduce your tax bill. They lower your income, which generally means your tax liability will be lower, too. Many taxpayers, however, are tempted to inflate the amounts that they claim on Schedule A.
The IRS, thanks to its automatic computer screening tool known as the discriminant information function (DIF), knows what the average deduction amount is for various income levels. If your claims are larger, you can bet your 1040 will be pulled for further review.
If you did indeed have an unusually large but legitimate charitable deductions, great. Claim those that you have receipts for and then show the IRS examiner your substantiating documentation. But if you’re just pumping up the amount on your own, you could face serious consequences.
5. Inflating self-employment expenses
This is the business counterpart to inflated individual itemized deductions. Here self-employed individuals bump up the business expenses they list on their Schedule C filings. This form filed by sole proprietors offers a way to claim a variety of business expenses that can reduce self-employment income and therefore the 15.3 self-employment tax. Among the expense categories are advertising costs, office supplies and other expenses, depreciation and Section 179 expenses, auto expenses and travel, meals and entertainment costs.
As you can see, there are lots of tempting opportunities to hike amounts to reduce taxable self-employment income. Were those stamps really for office mailings, or did you use them to send out personal holiday cards? What about that book? Was it really something that helps your run your company better or was it a volume you wanted for your personal bookshelf?
6. Mixing business and pleasure
A specific section of Schedule C that’s prone to, shall we say, shady claims is the meals and entertainment line item. When properly claimed, a business owner can deduct some of the costs of taking a client out to eat and/or an entertainment venue. But sometimes business folk go out with friends and then write it off as a business expense.
That’s not to say that you can’t be friends with other business owners or even your clients. But when you’re picking up the check, you need to make sure that the dining etc. experience is really work related. You can’t just go out with a friend, ask “how’s your business going?” and then claim the evening as a business expense. Well, you can, but if the IRS catches on to your expense ruse, you’re in trouble.
This also could be a tax problem if you combine business and personal travel. While that’s totally acceptable to the IRS, you can’t claim the travel costs as a business expense if you actually spent more time lounging on the beach instead of meeting with new clients for your new line of bathing suits.
Instead, make sure you know how to make the most of legitimate business entertainment expenses and travel expenses by hooking up with a tax professional.
7. Sharing your home office
A home office isn’t an automatic red flag but that doesn’t mean you should be cavalier in claiming your work space. If the room or specific area in a room isn’t used regularly and exclusively for your business dealings, it does not qualify as a home office.
Yes, it’s easy to ignore those personal files in your desk drawer. Afterall, when you worked at a cubical for your employer you had personal stuff there. But technically, you are illegally claiming this deduction if you conduct personal tasks in your so-called office.
8. Using whole, rounded numbers
Yes, round numbers are easier to add and subtract. Yes, your tax software rounds entries. And yes, even the IRS says you can round your entries on your 1040 to whole dollars.
But when it comes to deductions and expenses, it tends to make the IRS think that you are making up amounts. Now some people add tip amounts so that meal checks come out to even numbers. But those people should still keep those receipts. Other financial transactions, however, rarely end in .00. And since when to all your business expense you are claiming on your tax return end in round hundreds or thousands? At best, all those rounded numbers make it look like you didn’t keep good records showing precise amounts. And that could encourage the IRS to take a closer look at all your entries.
9. Improperly claiming a dependent
Sometimes determining just who is your tax dependent can be messy. There are lots of rules about relationships and support earned or provided and who lives for how long in your house. You also must have the Social Security number of the person regardless of relationship that gets put on the 1040.
Sometimes the confusion leads to an innocent mistake as to who is eligible to be listed as your tax dependent. Other times, though, folks knowing claim a person as dependent to get the added exemption amount or to claim the refundable Earned Income Tax Credit.
Faking dependents is not a good idea. The IRS knows this happens. It looks at who has and hasn’t been named before on your return. Plus, family situations often are messy enough without adding tax cheating to the mix.
10. Not making a profit
Legitimate business owners want to make money, even if it means paying taxes. Other folks, though, set up operations that they fully intend to run at a loss for tax purposes. That is the textbook definition of a tax evasion scheme.
The IRS is wise to this and tries to limit such losses by requiring that a business eventually make a profit. According to the IRS time table, eventually means you must be in the black in three out of five years.
Your inability to do so will cost you. And if the IRS can show your bleeding bottom line wasn’t just due to a lack of business aptitude, but a willful intent to operate at a loss, you will be deemed to have committed a tax sin.
Remember, carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.
Don’t Take The Chance And Lose Everything You Have Worked For.
Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego, San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.
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