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CCH provides special CCH Tax Briefings on key topics at: CCHGroup.com/Legislation/Briefings.

• As Recovery Plan Take Early Step in Congress, CCH Issues Special Tax Briefing
• New CCH Coverage of Recovery Plan with Senate Finance Committe Changes
• Senate Passes Recovery Plan with Expanded Homebuyer's Credit, Car Incentives, AMT Patch
• Final Stimulus Plan Provides Tax Breaks for Individuals, Businesses, Environment, Government
• CCH Briefing Analyzes Obama Administration Tax Proposals

Tax Avoidance vs. Tax Evasion: CCH Identifies 10 Tax Blunders with Unpleasant Consequences  

Whether resulting in penalties, back taxes, a miserable audit experience or jail time, there are certain moves taxpayers do not want to make

(RIVERWOODS, ILL., January 2009) – Everyone wants to avoid paying taxes when there is a legitimate way to do so, such as claiming appropriate tax credits and deductions; however, when people cross the line, failing to pay or intentionally underpaying their taxes, that’s tax evasion, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). Some people may look at it as an “extreme” way of saving on taxes, but in the eyes of the Internal Revenue Service and other U.S. government entities, it’s illegal.

“Sometimes, people truly do make mistakes and the IRS can be reasonable about these types of oversights, but when an individual is seen to be deliberately or repeatedly evading their tax obligations, the consequences can be very stiff,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA.

Below CCH reviews 10 tax blunders that can cross the line from tax avoidance to tax evasion.

1. Not reporting gambling income.

   If you receive money, prizes or awards of monetary value from winning the lottery, the local Boy Scout raffle or beauty contest, or you hit the jackpot at the casino, you are required to report this as income on Schedule A, line 28 of your tax return. Losses also are deductible, but only to the extent of the taxpayer’s gains from similar transactions.

   Also to be reported on that same line are any gains from illegal transactions, such as embezzlement or fraud. If you’re wondering who would report illegal gains, most people probably wouldn’t. This is why many notorious criminals, most famously, Al Capone, are charged with income tax evasion along with a long list of other infractions.

2. Not paying taxes on unemployment, wages, tips or other earned or unearned income.

   If you are out of work and receiving unemployment benefits, you have to pay taxes on the benefits. You either can instruct your state unemployment agency to withhold the taxes similar to how you would instruct your employer to withhold from a paycheck, or you have to pay quarterly estimated taxes on it.

   Likewise you are expected to report all your income from work – whether it comes in the form of wages or tips, and all investment income, including interest, dividends and capital gains.

   “Whether income is from working, investments or unemployment benefits, it’s all income in the eyes of the IRS, and you have to report it on your income tax returns,” said Luscombe.

3. Inappropriately reporting children’s investment income.

   For many years, parents were able to safely park a significant amount of investment income in their children’s name. If the child was 14 years of age or older, that income was then taxed at the child’s income tax level, which was generally considerably lower than their parent’s rate assuming the child had no or little other income.

   That’s changed for 2008 forward. As a result, a child’s investment income of more than $1,800 must be reported on the parent’s income tax return and taxed at the parent’s income tax rate if the child was under age 18 at the end of 2008; was 18 years old at the end of 2008 and did not have earned income that was more than half the child’s support; or the child was a full-time student 19 to 23 years of age and did not have earned income that was more than half of his or her support.

   “This was a popular tax avoidance strategy for upper-income families. However, as the law has now changed, it’s tax evasion if the parents do not report the income at the parents’ tax rate,” said Luscombe.

   Individuals need to use Form 8615 to figure out the tax for a child’s investment income.

4. Not paying the nanny tax.

   If you have household workers, you are required to withhold and pay FICA taxes if cash wages paid in 2008 totaled $1,600 or more ($1,700 in 2009). As the employer, you have to report and pay the required employment taxes for these domestic employees on Schedule H (Household Employment Taxes), with the tax amount then transferring to the appropriate line on your Form 1040 or 1040A. You may also want to consider paying the tax on a quarterly basis by having an additional amount withheld from your salary or by making a bigger quarterly estimated payment to ensure you are not underpaying your taxes, something the IRS will frown on.

   “Not paying the nanny tax is probably pretty common, but it’s also income tax evasion. In this economy, it also can leave household workers that get laid off without a safety net, because if these taxes weren’t being paid, they now will not be eligible for unemployment benefits,” said Luscombe.

5. Not reporting gifts given over $12,000.

   If you are lucky enough to receive a gift, its value is excludable from your gross income, meaning it’s not taxable to you. However, if you later receive any income from the gift, for example you sell it, that amount is then taxable.

   As the gift giver, if you gave a gift to an individual in excess of $12,000 in 2008 as a single filer or $24,000 as a split gift by joint filers ($13,000 and $26,000, respectively, in 2009), you either have to pay taxes on the amount above this limit or apply it against your lifetime gift tax exemption (which currently is $1 million). The tax on gifts ranges from 18 percent on taxable gifts below $10,000 to 45 percent on gifts of $1.5 million or more. If you don’t report the gift, it is considered tax evasion.

   “As a single filer, if you gave your nephew a car valued at $20,000 last year, you need to decide if you want to pay taxes on the $8,000 in excess of the allowable gift tax or have that amount applied to your lifetime gift tax exemption,” said Luscombe.

   Gifts are reported on Form 709.

6. Being overly charitable to oneself with charitable donations.

   One person’s junk may be another person’s treasure. However, the IRS expects people donating items to use fair market value in determining the value of the items; for non-cash donations of more than $500 a written description of the donated property must also be furnished. Additionally, cash donations of any amount now require proof, such as a cancelled check, credit card statement or receipt from the charity. Contributions of $250 or more also require a letter from the organization specifying the name of the donor, the amount given and the date received.

   “If a taxpayer does not have valid proof of a donation, the IRS will disallow the deduction and the taxpayer will have to pay taxes on that amount as well as potential penalties,” said Luscombe.

   (See Release 19 for a review of charitable contribution issues.)

7. Exaggerating expenses.

   Small business owners often have wads of receipts and for good reason: any deduction they want to take for expenses needs proof. Similarly, taxpayers undertaking a job search or teachers making classroom purchases that won’t be reimbursed all need to hold on to receipts if they want to deduct these expenses on their income tax returns.

   Also deductible for many individuals are mileage expenses. With gas prices sky-rocketing in 2008, Congress approved a mid-year increase in the mileage rate for many purposes. The business mileage rate through June 30, 2008 was 50.5 cents, increasing to 58.5 cents for the remainder of the year; medical and moving mileage rates through June 30, 2008 were 19 cents, increasing to 27 cents for the remainder of the year. The charitable mileage rate remained unchanged at 14 cents throughout 2008; though an increased charitable mileage rate of 36 cents before July 1 and 41 cents afterwards was added for those using their vehicles for volunteer work related to the Midwestern disasters.

   “You are required to keep a mileage log detailing the date, purpose and number of miles traveled in order to claim this deduction, and the IRS will consider it suspect if it appears the log was put together all at once as opposed to kept on an ongoing basis throughout the year,” said Luscombe.

   As with charitable donations, taxpayers who don’t have proof of expenses they are deducting will be required to pay back taxes and interest on non-substantiated deductions. Depending upon the extent of abuse, the IRS may take other measures as well.

8. Not filing a tax return.

   Most people are required to file a tax return and even those who are not can benefit from doing so, for example, by having the chance to get a refund on taxes already withheld or to claim the earned income credit, additional child tax credit, first-time homebuyer credit or the recovery rebate credit.

   Income thresholds for those who must file range based on age and filing status. For single filers under age 65, returns must be filed if they earn $8,950; returns must be filed for married couples under age 65 filing jointly if their income is $17,900 or more.

   “The U.S. income tax system is based on voluntary compliance. But that does not mean that compliance is not enforced. If you don’t file a tax return and you should, it’s considered income tax evasion and the IRS will hold you liable for back taxes, interest and penalties, which can include jail in the most serious situations,” said Luscombe.

   Tax returns are due on April 15. Taxpayers can file for an extension until October 15, but they must file the request (using IRS Form 4868) for an extension by April 15.

9. Filing an incomplete tax return.

   For most people, making an error on their tax return or not filling it out completely means a delay in any refund they may have coming and additional inquiries from the IRS. They may also be subject to additional payments and interest if it’s determined they owe more taxes. However, if the IRS determines someone is intentionally filing an incomplete or inaccurate return, this is tax evasion and the IRS will pursue it as such.

   “It’s not enough to file a return and feign ignorance. If the IRS has legitimate reason to believe a taxpayer is trying to thwart the system, they will pursue the issue and the taxpayer will be held accountable,” said Luscombe.

10. Double dipping on the tax rebate.

    While not technically tax evasion, the IRS will be watching for and, quickly turning away, people who try to take more than their fair share of the tax rebate. That said, some people are eligible for additional rebate proceeds based on changing life circumstances, such as a lower income or the addition of a child in 2008.

    For example, if you did not receive the maximum economic stimulus based on your 2007 income tax return, you may be eligible to recover up to the maximum based on your 2008 tax return. However, over the two years combined, you cannot exceed the maximum ($600 for single filers; $1,200 for joint filers) and $300 per child for eligible taxpayer. The recovery rebate credit should be reported on line 70 of your 1040.

    “The IRS is keeping tabs on this. If you try to claim more than you should, they won’t give it to you. So even if someone figures it doesn’t hurt to try, it really won’t do them any good to try,” said Luscombe.

    (See Release 7 for a review of the rebate rules.)

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem®, CCH® TeamMate, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com.

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