Imagine living in a nation with no taxes. That sounds like a utopia or a dream. But what we do know is that the Internal Revenue Service, or what I like to call Uncle Sam’s headquarters, does not always collect what it’s owed for a number of reasons.
Somewhere in the mix are those who cheat the system. Who are those people? An analysis of IRS data by the National Taxpayer Advocate indicates that potential tax cheats are most likely to be sole proprietors found in the areas around Los Angeles, San Francisco, Houston, Atlanta and Washington, D.C., The Associated Press reports. (If you fit that profile, you’re more likely to be audited.)
Of course, you don’t have to live in one of those areas to be considered a tax cheat, whether you did it intentionally or out of ignorance. In the video below, Money Talks News founder and CPA Stacy Johnson takes a closer look at how people cheat on their taxes. Watch the video, then meet me on the other side for more.
The sad reality of the “tax gap”
The 2012 Taxpayer Attitude Survey, released by the IRS Oversight Board a year ago, indicates that a vast majority of Americans have an issue with cheating on taxes: 87 percent of the 1,500 respondents said that behavior is unacceptable. Only 11 percent were tolerant of cheating “a little here and there or as much as possible.”
What actually happens when it’s time to file? For that, we referred to a Treasury Department analysis last year of the IRS’ last tax gap report.
The tax gap, defined as the “difference between true tax liability in any year and amount of tax that is paid voluntarily and on time,” amounted to an estimated $450 billion in tax year 2006 (or $385 billion after late payments come in). Underreporting accounted for an estimated $376 billion, while underpayment and non-filing amounted to $46 billion and $28 billion, respectively.
Considering the total tax liability was $2.66 trillion, the compliance rate was only 83.1 percent (or a net rate of 85.5 percent).
Whether noncompliance is due to ignorance or fraudulent intent, you can bet that Uncle Sam wants his piece of your hard-earned pie.
Common tax cheats
Any income generated throughout the year is taxable, but many don’t comply with that rule. For instance, Forbes says, “Americans report 99 percent of their wage income since they know the Internal Revenue Service is getting that information from their employers on W-2′s, but pay only 45 percent of the taxes owed in their non-checkable lives.”
While you may fly under the radar for the unreported $40 profit you made when you sold an item at last year’s yard sale for more than you originally paid for it, other forms of unreported income may get you into some trouble.
Attempts are also made at writing off items such as commuting expenses to and from work, unqualified business expenses, legal fees, and medical expenses for furry companions to reduce taxable income.
And let’s not forget about those who earn a large portion of their income in cash; I’m certain some of the cash is magically unaccounted for at tax time.
The IRS is cracking down
The IRS has stepped up its effort to detect the underreporting of income, particularly by small businesses. While you will more than likely not be singled out by Uncle Sam, I want to wish you the best of luck if you are selected for extra attention. The IRS does not disclose how it selects audit candidates, but there are red flags that can make you stick out like a sore thumb — some of which suggest you are hiding income or taking deductions you’re not entitled to.
So, it’s important to protect yourself by:
- Accurately reporting all income, even if you are paid primarily in cash.
- Seeking free assistance with your return if needed.
- If you feel you must hire a professional to prepare your tax return, selecting one who’s honest and experienced.
It’s also important to note that being victimized by a scam does not necessarily get you off the hook; you are still the one to blame until the IRS decides otherwise.
Hefty penalties await those who cheat
If you are caught cheating Uncle Sam out of what he is owed, whether through dishonesty or ignorance, your wallet could take a beating. The IRS assesses a penalty of 20 percent of the net understatement of tax for “substantial understatement” and “negligence or disregard of the rules or regulations” violations.
On the other hand, frivolous returns are subject to a $5,000 fine, and civil fraud penalties amount to 75 percent of the understated outstanding tax liability and could result in criminal prosecution.
While it may be tempting to cheat on your taxes to save money or get that large refund, it definitely isn’t worth it. And if you do decide to test your luck, you may find yourself among that 1 percent whose returns are audited.