2010 CCH Whole Ball of Tax
CCH Outlines Tax Mistakes with Serious Consequences – from Back Taxes to Prison Time
(RIVERWOODS, ILL., January 2010) – Attempting to avoid taxes by taking qualified credits or deductions is perfectly legitimate and generally good tax planning. However, taking undeserved tax breaks is not tax avoidance but tax evasion, and it’s illegal, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).
“The tax code is complicated. Honest mistakes happen and the IRS can be reasonable in these instances, for example, simply requiring the taxpayer to pay back taxes and interest,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. “However, intentional attempts to circumvent the tax code result in far harsher treatment, from costly penalties to incarceration.”
Below CCH reviews 10 tax blunders that can leave taxpayers facing unpleasant consequences.
1. Not paying taxes on income earned from offshore accounts.
In March 2009, the IRS announced special provisions to allow taxpayers to voluntarily disclose unreported income held in hidden offshore accounts. Under the provisions, taxpayers who came forward would be able to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. The special provisions expired October 15, 2009. Nearly 15,000 Americans living and working in more than 70 countries came forward. Taxpayers who have not come forward and are subsequently detected by the IRS will face significant penalties and increased risk of criminal prosecution.
“Many of these account holders have millions of dollars supposedly out of reach of the IRS, representing millions more in unpaid taxes,” said Luscombe. “However, recovering taxes owed from offshore tax havens is a major IRS initiative as it tries to shut down abusive tax schemes.”
In an effort to collect more unreported income, several states also had their own amnesty programs in 2009 with others planning programs for 2010. Types of taxes covered under the amnesty programs vary state to state but can apply to income, sales and use, property, gift and estate taxes.
2. Not reporting income from gambling or from Ponzi schemes and other illegal activities.
Schedule A, line 28 of the tax return is a bit of a catch all for reporting gains from various vices. So, whether a taxpayer had a profitable night at the casino or had earnings from illegal transactions, such as a Ponzi scheme, embezzlement or other types of fraud, line 28 is where they need to tell all. In the case of ill-gotten gains, most swindlers aren’t likely to report this income, which is why they are often charged with income tax evasion when they’re finally caught.
On the flipside, victims of embezzlement can report the amount lost from embezzlement as theft loss and deduct this from their taxes. To qualify as a theft loss there has to be an allegation by someone that there was a criminal theft, however, this generally is the case with Ponzi schemes and other embezzlement situations. (For more on Ponzi schemes, see Release 4.)
3. Chronic Under-withholding of taxes.
Generally, income tax follows a pay-as-you-go approach, meaning taxpayers must pay taxes on income they earn during the year it’s earned. This is done through withholding or by paying estimated taxes on a quarterly basis. Under-withholding results in owing back taxes as well as a possible penalty, which is typically interest on the amount under-withheld. The penalty can be waived under certain circumstances, such as if failure to make estimated payments was caused by casualty or disaster. People generally try to avoid under-withholding by making sure they pay at least as much as they paid in taxes the previous year or by paying through withholdings or estimated taxes 90 percent of what was owed for the current year.
Self-employed taxpayers are among those most likely to fall into under-withholding – particularly those who have highly fluctuating incomes making accurate estimating difficult. For 2009 and 2010, many people who are not entitled to receive the Making Work Pay Credit may also find they have under-withheld if they did not adjust their withholding or pay estimated taxes to offset withholding reductions. (For more on the Making Work Pay Credit, see Release 8.)
4. Non-authorized use of the First-Time Homebuyer Credit.
Under the American Recovery and Reinvestment Act of 2009, the First-Time Homebuyer Credit was increased to $8,000 and extended until November 30, 2009. (Previously, the maximum credit was $7,500 and other restrictions had applied.) Subsequently, it’s been extended again to April 30, 2010 and expanded to any homebuyer meeting income and other requirements. The credit is claimed on Form 5405, First-Time Homebuyer Credit.
“This credit has been a moving target, so it’s not surprising that some people may inadvertently be claiming the credit when they’re not qualified. However, other people may be fully aware of the rules but simply trying to circumvent them for their own advantage,” said Luscombe.
Treasury Inspector General for the Tax Administration J. Russell George told the House Ways and Means Committee that tens of thousands of ineligible taxpayers may have claimed the credit so far. These include:
- Nearly 74,000 claims by taxpayers who had indication of prior home ownership, for example, had claimed mortgage interest deductions or real estate taxes on previous tax returns;
- Approximately 19,300 taxpayers who claimed the credit for a future home purchase; and
- More than 580 taxpayers younger than 18 years of age who claimed the credit. (For more on the homeowner credits, see Release 10.)
5. Not paying taxes on unemployment, wages, tips or other income.
For 2009, the first $2,400 in unemployment benefits is excluded from income. However, beneficiaries are expected to pay taxes on the remaining benefits they received. Likewise, workers are expected to report all their income from work – whether it comes in the form of wages or tips. All investment income, including interest, dividends and capital gains, also is income and has its own tax ramifications.
“Generally, the biggest abuses come from people who earn part of their income from tips or those who are working off-the-books, for example doing side jobs and simply not reporting the income,” said Luscombe. (For more on unemployment benefits and taxes, see Release 9.)
6. Not paying taxes on household help.
Taxpayers who have a nanny or other household workers are required to withhold and pay FICA taxes if cash wages paid in 2009 totaled $1,700 or more. They also 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 their Form 1040 or 1040A. Taxpayers with household workers may also want to consider paying the tax on a quarterly basis by having an additional amount withheld from their salary or by making a bigger quarterly estimated payment to ensure they are not underpaying taxes, which would subject them to additional penalties.
“Some people think they’re helping out their household help by paying them a bit more while not paying taxes, but that’s not the case,” said Luscombe. “First, not paying the tax is tax evasion and, second, not paying the tax can actually put the domestic worker at more risk because they will not be eligible for unemployment benefits if they are laid off.”
7. Not reporting gifts given over $13,000.
When someone receives a gift, its value is excludable from their gross income, meaning it’s not taxable to them. However, if they later sell it or receive any other income from the gift, that amount is then taxable.
Taxpayers giving gifts in excess of $13,000 in 2009 as a single filer or $26,000 as a split gift by joint filers have one of two options to satisfy their tax obligation. They can either pay taxes on the amount above this limit or apply it against their 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. Not reporting the gift is considered tax evasion. Gifts are reported on Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return.
“As a single filer, if you gave your niece 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. “Your niece owes no taxes on receiving the gift. However, if she sells it a few years from now, she owes taxes on the sale amount.”
8. Inflating the value of charitable donations.
While guessing is easier, and sometimes more profitable, 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 and non-cash donations of more than $5,000 must be appraised. Additionally, cash donations of any amount 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 interest and potential penalties,” said Luscombe.
9. Exaggerating business expenses.
The IRS is well aware of abusive tax schemes where taxpayers inflate business expenses or attempt to write-off personal and family expenses under the guise of a home-based business – where either no business exists or the deductions are clearly invalid, as they are not related to the business.
“Some home-business owners are under the misperception that as long as they keep their receipts everything is deductible,” said Luscombe. “However, the costs of heating your entire home just to keep the office warm or payments to your kids for doing household chores are not deductible expenses for your business.”
For expenses to qualify as business deductions, they must be ordinary and necessary expenses paid or incurred in carrying on a trade or business. Taxpayers must have proof to legitimize business deductions such as receipts. If they cannot show proof of expenses, they will be required to pay back taxes and interest on non-substantiated deductions. The IRS may take other measures depending upon the extent of the abuse.
Sole proprietorships claim business expenses on Schedule C, Profit or Loss from Business; partnerships and joint ventures generally report expenses on Form 1065 or 1065-B.
10. Not filing a tax return.
Ever since the enactment of the federal income tax in 1913, people have challenged the tax on various grounds. However, these challenges are consistently unsuccessful and most people are required to file a federal income tax return.
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 $9,350; returns must be filed for married couples under age 65 filing jointly if their income is $18,700 or more. Not filing a tax return when required is considered income tax evasion with penalties including paying back taxes, interest, possible fines and potentially serving a prison sentence in the most serious cases.
The deadline for filing is 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.
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. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands ( www.wolterskluwer.com).
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