IRS Red Flags to Avoid
Honest mistakes on tax returns are common, but if the IRS senses you're trying to cheat them, expect penalties, interest and possible jail time.
Honest mistakes on tax returns are common, given the mind-numbing complexity of the rules. Generally, a mere error will cost you a minor interest charge — plus the additional tax owed, of course. But if the IRS senses you made an effort to hide income or took an incorrect deduction, there could be penalties on top of interest. And, yes, serious tax cheats can go to prison.
CCH, an Illinois tax-information firm, lists 10 offenses the IRS takes most seriously. Some are fairly obvious, like failing to file a return. Ignore advisers who say taxes are unconstitutional. Some of them are now behind bars, kept company by some of their disciples.
Inflating business expenses and charitable donations are serious offenses, too. To be legitimate, business expenses must be ordinary and necessary costs of doing business, and it’s not OK to fudge the lines between business expenses and personal ones. If you have a home office, for example, you cannot write off the cost of heating the entire home.
Charitable donations have to be documented. You cannot give away a pile of threadbare T-shirts and claim they were designer wear worth thousands. Keep canceled checks, credit card statements and receipts from charities.
Some offenses are laughable, such as failing to report income from gambling or illegal activities like Ponzi schemes. (Income from embezzlement and similar crimes is reported on line 28 of the 1040 form, by the way.)
Other tax misdeeds are classics, including the failure to pay the “nanny tax” on household help. That’s the one that so often trips up people seeking public office. You should withhold and pay FICA taxes if you paid the worker $1,700 or more. These and other taxes for household help are reported on Schedule H.
Gifts worth more than $13,000, if given by an individual, or $26,000 if given by a couple filing a joint return, have to be reported. The giver can either pay tax on the amount above the limit or apply that amount to the $1 million lifetime gift tax exemption. Gift tax rates range from 18% to 45%. Use Form 709.
Chronic under-withholding can be a serious matter, too. This is when you have too little withheld from your paycheck, or pay too little in quarterly estimated taxes, a major issue for the self-employed.
The last three on the list of don’ts are somewhat arcane. One is not paying tax on income earned from offshore accounts, such as tax-dodging accounts set up in Switzerland or the Cayman Islands. The government is on a big push to find these.
Another is improperly claiming the $8,000 credit for first-time homebuyers, which is available through April under one of the economic stimulus measures enacted in 2009.
Finally, the IRS is on the lookout for people who are not paying taxes due on unemployment compensation, tips and other commonly concealed income. Only the first $2,400 of unemployment compensation is exempt. Of the rest, sadly, a share belongs to Uncle Sam.