Not every fraud artist is a sketchy identity thief or faux Nigerian prince from the dark corners of the internet. You might end up committing accidental tax fraud or accidental tax evasion if you don’t pay careful attention this tax season.
Individual slip-ups usually result from negligence rather than ill intent, but even white lies fall into the latter category. The IRS is serious about nipping fraud in the bud, which is why you should check and double-check your return before filing your taxes to avoid tax fraud penalties. Get the deductions and credits you’re entitled to, but make sure you do it legally. So that you don’t accidentally commit tax fraud, educate yourself on how do you commit tax fraud and check out these seven common mistakes to avoid when filing taxes.
What Is Tax Fraud?
Wondering how to commit tax fraud? The IRS defines tax fraud as “an intentional wrongdoing on the part of a taxpayer with the specific purpose of evading a tax known or believed to be owing.” To meet the IRS’s tax fraud definition, there must be both a tax due and owing, and fraudulent intent. Keep reading to find out about tax fraud examples that might surprise you.
1. Filing a Return With Missing or Incorrect Information
It’s crucial to file complete and accurate tax returns — or you might be committing tax fraud. For example, if you paid thousands of dollars to attend college this year, you might be eligible to claim an education tax credit to reduce your taxes.
If you claim an education credit, however, don’t forget to include Form 8863 — for education credits — with your return. Forgetting to include vital data like your Social Security number — or entering it incorrectly — also creates headaches.
How to avoid it: Professional tax preparers or tax preparation software can come in handy. Often, tax software with built-in e-filing won’t let you submit your forms unless all your necessary data is included.
Potential penalty: Typically, if you forget or make a mistake on your return information you’ll experience delayed processing of your tax return. Keep in mind that omissions prompt the IRS to take a closer look at your forms — and maybe even target you for tax fraud. If omitted data changes your status from owing money to getting a refund — or even just makes your refund higher — your mistake could be interpreted as willful failure to supply information, which comes with penalties of up to a year in prison, $100,000 in fines or both.
Related: 31 Tips When Doing Your Own Taxes
2. Incorrectly Claiming the Earned Income Tax Credit
Claiming the earned income tax credit when you’re not eligible for it is a major IRS audit trigger. If you qualify for the credit, which is designed to offset the burden of Social Security taxes for low-to-moderate earners, you can get credited up to $6,431 — but you must meet specific requirements. When filing your 2018 taxes, the EITC income limits range from $15,270 to $54,884, depending on your marital status and number of qualifying children.
How to avoid it: Don’t file for the EITC if you have investment income exceeding $3,500. Child support, alimony, Social Security benefits and unemployment benefits do not contribute toward earned income. Your eligibility might fluctuate from year to year, so read the requirements closely each tax season.
Potential penalty: This issue could result in a delay, denial or required payback of your EITC refund — and possibly a ban from claiming the EITC for anywhere from two to 10 years.
3. Abusing Tax Shelters
Chances are, a tax shelter that sounds too good to be true likely is. Often, accountants and wealth planners tempt taxpayers with vague or deceptive tax shelter “opportunities,” or offer “captive” insurance structures that are at odds with your genuine financial needs, duplicate your existing coverage or provide coverage for totally implausible events. Your barbershop in Indiana probably isn’t going to get attacked by tigers, so don’t use that excuse as a tax shelter.
How to avoid it: If you’re in over your head on tax shelters, seek out an independent opinion. Be especially wary of ambiguous micro-captive insurance tax shelters, which have been highlighted for the past four years on the IRS’s annual “Dirty Dozen” list of tax scams.
Potential penalty: “These scams can end up costing taxpayers more in penalties, back taxes and interest than they saved in the first place,” said former IRS Commissioner John Koskinen. In addition, the IRS can count this as tax avoidance or evasion, which might net you fines of up to $250,000 and jail time of up to five years, with the average jail time for tax evasion at three to five years, according to the law firm Golding & Golding.
4. Claiming the Wrong Deductions
For the 2018 tax year, job-related expense deductions have been eliminated for individuals but if you are a small business owner or self-employed, you can still deduct necessary business expenses. However, you should make sure an expense is really necessary before you try to deduct it. If you think it’s clever to take the family along on a business trip just to deduct the vacation as a business expense, think again. When April rolls around, forget about claiming your family’s side trip to Disneyland.
Some commonly misused deductions — likes writing off groceries that you didn’t explicitly buy for clients or employees — are just plain mistakes. But if you are knowingly lying on your tax return to get more money, expect trouble.
How to avoid it: Again, tax prep software helps prevent errors — it typically shows the deductions for which you qualify. If you’re going “old school,” explore the IRS website, which offers tips for deducting business expenses and full breakdowns of what you can legally deduct. Key IRS documents like publications 334, 535 and 538 detail eligible business expenses and offer tax guides for small businesses.
Potential penalty: If you’re guilty of fraudulent activity or false statements, you could be looking at some combination of imprisonment of up to three years and fines of up to $100,000.
5. Taking Inflated Deductions
Your chances of being audited are low. In 2017, the IRS audited 1.1 million tax returns, which is only about 0.5 percent of all returns filed in calendar year 2016, the latest year for which this information is available. That might make it tempting to claim your whole basement as a home office deduction, but don’t.
Even if the chances of getting caught are low, inflated deductions are still illegal. “You don’t want to roll the roulette wheel and have the little white ball land on your number,” said Koskinen.
How to avoid it: Don’t stretch the truth. If you think you’ll have trouble paying what you owe all at once, work out a payment plan or installment agreement with the IRS via its Online Payment Agreement Tool or Form 9456.
Potential penalty: For an incorrect filing like this, the IRS can hit you with a $5,000 fine, a fee of 20 percent of the disallowed amount or a penalty in the amount of 75 percent of the full income tax you owe. You might even face an IRS criminal investigation.
6. Failing to Report Income
It’s easy to not claim all your tips — in fact, the IRS estimates up to 40 percent of tips go unreported. But don’t get too comfy — failing to report your income to the Internal Revenue Service might count as tax fraud and evasion, or failure to supply information.
How to avoid it: If you’re a server, keep a daily record of all tips you receive and use Publication 531 to report your tip income. Whether you’re a server or not, don’t fall victim to common misconceptions — use the most recent version of Publication 525 to keep track of what the IRS considers taxable and nontaxable income.
Potential penalty: For not reporting tips, you’re subject to a penalty equal to 50 percent of the Social Security, Medicare, Medicare or Railroad Retirement taxes you owe on unreported tips. Regardless of your industry, tax evasion penalties can cost you up to five years in prison and up to $250,000 in cash.
7. Falling Victim to Tax Preparer Fraud
“Choose your return preparer carefully because you entrust them with your private financial information that needs to be protected,” said Koskinen. About 56 percent of U.S. taxpayers use tax professionals to prep their returns — and the vast majority of those pros are honest, according to the IRS. It’s possible, however, that the preparer you rely on might dupe you into claiming credits or deductions you’re not entitled to in order to increase his own fee.
How to avoid it: When choosing a tax preparer, always confirm his IRS Preparer Tax Identification Number and professional credentials via the online IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications.
Potential penalty: Penalties like jail time typically fall on the preparers for defrauding their clients. If you get caught up in an illegal scam, though, you’ll be up against what the IRS calls “significant penalties,” which include interest charges and possible criminal prosecution. To report preparer tax fraud, use Form 14157.
More on Taxes
- Trump’s Tax Reform: How All the New laws Will Affect Your Taxes
- How Much Money You Would Have If You Never Paid Taxes
- States With Inheritance Tax
- Watch: How to Legally Cheat Your Tax Bracket
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Gabrielle Olya contributed to the reporting for this article.