Taxes are complicated, so it’s no wonder that everyone makes mistakes from time to time. But some actions go beyond incorrect arithmetic or thinking something is deductible when it’s not. Some actions can cost you tax breaks you might otherwise have been entitled to. And some actions can land you in serious trouble with the IRS, triggering steep civil penalties and, in some case, criminal penalties. Here are actions to always avoid:
1. Not filing returns
If you meet the annual tax filing threshold for your filing status, you must file an income tax return, even if you don’t owe any money. If you don’t file, the IRS can complete a tax return for you, and may say you owe taxes. If no return is filed, the IRS has an unlimited amount of time to take action with the blank tax year (the year for which you didn’t file a return).
2. Faking documentation
Once you’re called for an audit, it won’t help you to retroactively create the records you should have been maintaining all along. For example, the IRS has been known to use experts for detecting fake car mileage logs (those prepared in one sitting using different color ink to make it look as if it were done contemporaneously with the dates of the trips). Faking documents can amount to a crime (see Tonya Womack and Donald Ray Womack, CA-5, 2012, who were convicted for creating fictitious mileage logs as well as other actions on behalf of their clients).
Even if there’s no fraud involved, sloppy documents can be costly, too (see Sin #7 below). In one case, mileage logs that had questionable and missing entries resulted in the complete disallowance of a couple’s deduction for car use (Moore, TC Summary Opinion 2012-16).
3. Claiming breaks you’re not entitled to
A March 2014 report from Treasury Inspector General for Tax Administration found that 22% to 26% of earned income tax credit (EITC) payments were issued improperly in the government’s 2013 fiscal year, totaling $13.3 to $15.6 billion. This red flag has put the IRS on the alert (if it weren’t already on the alert) to bogus tax credit claims. Because the EITC is refundable, it is even more susceptible to fraud than many other tax breaks.
The EITC isn’t the only tax write-off that’s abused. There are frequent examples of false charitable contributions and dependency exemptions, as well as “creative” deductions (e.g., treating a veterinarian’s bill for a family pet as a personal medical expense).
4. Failing to report income
Intentional omissions of income can result in stiff penalties when discovered. And the IRS has more time than usual—six years instead of three years—to audit a return that omits more than 25% of gross income.
5. Concealing foreign accounts
If you have foreign bank or investment accounts, you are required to report them annually if the aggregate value of all such accounts exceeds $10,000 at any time during the year (find more information about FBAR reporting at www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR). Some individuals have concealed these accounts to avoid reporting the income they earn from them (or for personal reasons, such as keeping them out of the hands of creditors or former spouses). Whatever the reason for failing to report these accounts, the penalties can be severe, and the IRS now has the help of many foreign banks and financial institutions to help them track down U.S. depositors and investors.
6. Misreporting information
Being careful can avoid attracting IRS scrutiny to your return; make sure that any tax information reported to you on a 1099, W-2, K-1, or other information return is reported properly on your income tax return. Mismatching will be detected by IRS computers and a letter will be generated if additional taxes are owed. When omissions are significant, the IRS may choose to do a bigger—and more painful—audit.
7. Ignoring substantiation rules
To paraphrase a famous slogan: Tax deductions are a terrible thing to waste. But if you don’t have required records—receipts, diaries and logs, acknowledgments, etc.—you can lose deductions and credits to which you would otherwise be entitled.
If you’ve committed any of these tax sins, contact a tax attorney immediately (an attorney is bound by privilege, which protects your disclosures to him or her in case of any criminal activities). If you come forward and correct your actions before the IRS catches you, things will go a whole lot better and be a lot less costly in terms of penalties and other sanctions.