- Self-employed taxpayers
- Underreported income
- Unscrupulous tax preparers
- Phony deductions or credits
- Inflating the Earned Income Tax
- Taking fake education credits
- Petty cheating
refer to it as “creative accounting” or just “a little fudging here and there,”
but if your tax return is missing some income that should have been reported or
includes overstated deductions, regardless of whether you prepared your own
return or had it prepared, you are the one who is ultimately responsible. If
you get caught, there can be very unpleasant consequences – including substantial
monetary penalties and the possibility of jail time for blatant cases.
who fudge on their taxes may think that they are just cheating the government
out of money. In actuality, however, the government is going to get the taxes
it needs from somewhere, so those who fudge on their taxes are causing others
to pay more.
Currently, just short of 50% of all U.S. taxpayers
pay no income tax. In fact, a large percentage of these folks actually get
money back from the government because their income is low and they qualify for
certain refundable tax credits. How many of those not paying any tax are doing
so because they are either not reporting all of their income or exaggerating
their deductions? There are no statistics on the issue, but it would seem to be
a large number.
One of the biggest areas of cheating involves
self-employed individuals not reporting cash payments. Some will even go so far
as to offer discounts for cash payments; these discounts, of course, are
attractive, and customers often opt for them, thus enabling the self-employed
individuals to cheat on their taxes. However, if self-employed individuals get
caught – perhaps because their lifestyles aren’t supported by their reported income
– they can end up with a nasty tax bill and penalties. Plus, when the IRS finds
a cheater, it usually audits that person’s or company’s returns for other years.
Especially troubling is knowing that some individuals
who underreport their income are not just avoiding income taxes, but qualifying
for low-income tax credits and other subsidies meant for those who really need
Unscrupulous tax preparers also cheat, and
you could end up being the victim. Here are some of the schemes they pull:
- Adding phony
deductions or credits – They do your return correctly and tell you what
your refund is. Then, before they e-file it, the preparer adds phony
deductions or credits to inflate the refund. The refund amount you expect is
direct-deposited to your account, but the extra amount is sent to their
- Inflating the Earned
– Earned Income Tax Credit (EITC) is a refundable tax credit for low-income
taxpayers that is based upon the amount of the taxpayer’s income from
working (earned income). The credit increases up to a point as the
taxpayer’s earned income increases, then phases out for higher-income
taxpayers. This credit is the frequent target of scams, and one of the
most common is to create earned income by fabricating self-employment
income of an amount that will result in the maximum EITC. Even though this
may create more taxes, the EITC is greater than the taxes, netting an
increase in the taxpayer’s refund.
- Taking fake
education credits – Another frequent scam is to claim a higher education
tax credit, especially the partially refundable American Opportunity Tax
Credit (AOTC), using made-up education expenses. The AOTC can be as much
as $2,500, and $1,000 of that amount is refundable.
If you were a victim of an unscrupulous tax
preparer and need assistance, please call this office.
Petty cheating is also prevalent. The
following lists common areas of cheating and the steps that the IRS takes to
- Inflating the value of noncash goods donated to charity – This is probably one
of the most commonly inflated tax deductions.
Countermeasures: The IRS requires documentation from the
charity, and if the value of the donation is more than $500 for the year, a
detailed list of the items that the
taxpayer contributed. The IRS will generally include charitable contributions
in every audit, no matter what triggered the audit in the first place.
- Claiming fictitious cash contributions – This typically
involves claiming that cash was donated through a house of worship’s collection
plate or holiday charity kettle.
Countermeasures: All cash contributions must be verified with
a bank record or a written record from the charity. Without such a record, no
deduction is allowed.
- Purchasing an item at a charity event – Generally, when
you receive something of value for making a donation, the value of that item is
not a deductible charitable contribution. Thus, the cost of pancake breakfasts,
charity auctions, Girl Scout cookies, car washes, and the like are not
deductible as charitable contributions.
Countermeasures: The IRS requires
charities to include the value of goods or services provided to the donor on
the charity’s receipt, making it easy for the IRS to detect when improper
deductions are being taken when it examines the receipts during an audit.
- Donating cars to charity – At one time,
individuals were donating vehicles that were close to being scrapped and then deducting
the blue book value for the vehicle as if it were in good or better condition.
This trend became so prevalent that Congress actually stepped in and limited
the vehicle contribution to $500 (generally).
Countermeasures: The IRS now requires the charity to issue a Form
1098-C to the donor; this form includes the information that needs to be
reported if the vehicle contribution meets the requirements for a contribution
greater than $500.
- Using a business vehicle for personal purposes – Have you seen pickups
and other trucks with company logos on their doors towing boats and trailers
down the highway? There is a good chance that the drivers of these trucks are writing
off the mileage through their businesses.
Countermeasures: The IRS
generally requires businesses, especially closely held ones, to verify the
business use of their vehicles (particularly those that are suitable for
personal use) with a log, including the odometer readings for the start and
finish of each business use.
- Deducting more home mortgage interest than entitled
law limits the amount that can be deducted for home mortgage interest to the
interest paid on $1 million in debt ($750,000 for debt incurred after December
15, 2017) from purchasing or improving a home. This limit applies to a taxpayer’s
first and second homes only. Many taxpayers simply take the mortgage interest from
the Form 1098 provided by the lender without any regard to these limitations.
Countermeasures: IRS Form 1098
requires lenders to include additional information that will allow the IRS
computer to determine whether the limits have been exceeded.
- Making repairs on a personal home and deducting the
expenses on a rental or business property – It is pretty easy for landlords or
owners of business real estate to make repairs on their personal homes and then
deduct those repairs on their rental or business properties.
Countermeasures: An auditor will
look at the dates and addresses on receipts to ensure that they make sense. If an
auditor catches such a violation, expect him or her to become very aggressive
in other areas and to possibly invoke substantial penalties due to the intentional
disregard of laws and regulations.
- Falsifying investment costs to minimize gain – Until a few years
ago, it was up to taxpayers to track their basis in the securities they owned. Inflating
the cost was prevalent before the IRS required brokers to begin tracking basis.
Countermeasures: The IRS modified
Form 1099-B, issued by brokers when stocks, bonds, etc., are sold, to include
the basis if known, and to indicate otherwise if basis was unknown. Then, the
IRS developed Form 8949 to separate investment sales into those for which the
broker was tracking the basis and those for which the broker did not know the
basis or wasn’t required to track the basis. The information included on these
forms allows the IRS to focus on those sales for which the taxpayer was
tracking the basis.
If you have an acquaintance who has been less
than honest on their tax returns in the past or has been the victim of a
dishonest or inept tax preparer, please have them give this office a call.