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Cheat On Your Tax Return? Having Second Thoughts?

by
Lee Reams, BSME, EA
on
4/24/2016
Cheat On Your Tax Return? Having Second Thoughts?

You may call it “creative accounting” or “a little fudging here and there,” but if you purposely underreport your income or overstate your deductions, that is still cheating, and if you get caught, there can be very unpleasant consequences – including substantial monetary penalties and the possibility of jail time for blatant cases. Those who cheat 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 cheat 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 they are low income and 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 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 are underreporting their income are not just avoiding income taxes but qualifying for low-income tax credits and other subsidies that are meant for those who really need them.

Petty cheating is also prevalent. The following lists common areas of cheating and the steps that the IRS takes to counter them.

  • Inflating the value of noncash goods donated to charity – This is probably one of the most commonly inflated tax deductions. IRS Countermeasures:The IRS requires documentation from the charity and adetailed list of the items that the taxpayer contributed if the amount is $250 or more for the year. 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. IRS 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 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. IRS 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 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). IRS Countermeasures:The IRS now requires the charity to issue a Form 1098-Cto the donee; 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 those 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. IRS Countermeasures: The IRS generally requires businesses, especially closely held ones, to verify the business use of its 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 – Tax law limits the amount that can be deducted for home mortgage interest to the interest paid on $1 million in debt from purchasing or improving a home, plus $100,000 of other debt. This limit applies to a taxpayer’s first and second homes only. Many taxpayers simply take the mortgage interest from the Form 1098 that the lender provides without any regard to these limitations. IRS Countermeasures: Beginning in the 2016 tax year, the IRS revised Form 1098, requiring lenders to include additional information that will allow the IRS computer to determine if 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 to deduct those repairs on their rental or business properties. IRS 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. IRS Countermeasures: The IRS developed Form 8949 for separating investment sales into those for which the broker was tracking the basis and those for which the broker did not know the basis. This breakdown allows the IRS to focus on those sales for which the taxpayer was tracking the basis.

If you have been less than honest on your tax returns in the past and want to come clean so that you can sleep better at night, please give one of our TaxBuzz professionals a call.

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Lee Reams, BSME, EA

Lee Reams, BSME, EA

Editor-in-Chief

Besides his role at CountingWorks as an educator and speaker to thousands of accountants nationwide, Lee manages a technical research service for a large group of tax accountants which sharpens his technical skills. Lee served on the Board of Blackline Systems, is a former Board of Director for the California Tax Education Council, is a Past President of the San Fernando Valley Chapter of Enrolled Agents, Member and Past Director for the California Society of Enrolled Agents.

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