Avoid an Audit: 6 Tax Lessons from Celebrities
Few people like to pay taxes, yet most dutifully send off their returns to the IRS every year. But some – including a few famous faces – aren’t content to merely grumble about how much they owe Uncle Sam. Celebrity tax cheats and other tax evaders may risk an IRS audit and other serious penalties by failing to file tax returns, making up fake business expenses, or trying to disguise how much money they really made, all to avoid sending their money to the IRS.
These tax scofflaws cost the government a lot of money. In 2006, the latest year for which statistics are available, the IRS reported a “tax gap” — the amount of owed taxes that weren’t paid on time — of $385 billion. Underreporting income accounted for $376 billion of the IRS’s missing money. Not filing returns and underpaying taxes owed were the other two big causes. Innocent accounting mistakes or taxpayers who want to pay but aren’t able to cause some of the tax gap, but deliberate fraud is also to blame.
Over the past three years, the IRS has launched roughly 4,500 criminal investigations annually related to tax code violations (these aren’t the same as audits, which are much more common — 1.2 million people were audited in 2014). The number of investigations is relatively small, but once the IRS starts pursuing a case, there’s a good chance it will lead to a conviction and prison time for the offender. Of the 3,853 investigations in 2015, 75% eventually led to a conviction.
Most people aren’t committing tax fraud on a level that would lead to an IRS investigation and prison time. But there are still things to learn from those who did find themselves caught in the IRS’s crosshairs. Here are six tax lessons from celebrities who found themselves in trouble with the IRS.
1. Yes, you do have to pay taxes
In 2008, Wesley Snipes was sentenced to three years in prison for failing to file tax returns from 1999 through 2001, costing the federal government $7 million.
The Blade star’s failure to pay taxes wasn’t an oversight. Rather, Snipes was a “tax protestor” who challenged the federal government’s authority to collect taxes. According to court documents, the actor engaged in “a long conversation with the IRS” in which he offered various arguments for why he did not have to pay taxes. This included sending “treatises describing theories about why the IRS was powerless to collect income taxes from him and several altered tax forms demanding money for taxes he had rendered in earlier years.”
The IRS wasn’t persuaded by Snipes’s arguments. “The requirement to pay taxes is not voluntary,” the IRS notes in a document titled “The Truth About Frivolous Tax Arguments.” Snipes was eventually convicted of tax evasion and served three years. He was released from prison in 2013.
2. Don’t try to hide your income
Don’t make the mistake of attempting to hide money from the IRS, as Survivor winner Richard Hatch learned the hard way. Hatch won a $1 million prize for coming out on top in the first season of the reality show, but never paid taxes on that money. He was convicted of tax evasion and served time in prison. After his release, Hatch even starred in an advertisement warning people they could go to jail for screwing up on their taxes.
As Hatch’s case demonstrates, the IRS expects you to pay taxes on all of your income, including prize money and gambling winnings. Don’t panic, however, if you genuinely forget to include some of your income on your return. The IRS knows people make mistakes and permits you to file an amended return and get squared away. But if you’re deliberately trying to cheat the tax man, watch out.
“If the IRS can prove intent, or bad purpose, the fraud might have criminal implications (imprisonment, fines),” Al Rucker, a former IRS criminal investigator said in an interview on the QuickBooks blog. “If the incident lacks intent or is less than $10,000 or so in underpaid tax, civil penalties, as well as a civil fraud penalty, may instead be applied.”
3. Don’t live beyond your means
Some celebrities get into trouble with the IRS because they believe the law doesn’t apply to them. But in the case of Academy Award-winner Nicolas Cage, the problems seem to go much deeper. Sure, he got into hot water with the IRS for improperly writing off numerous personal expenses, including his private jet, according to a report in Forbes. But a lavish lifestyle, which included purchasing more than a dozen homes (including multiple castles), yachts, and luxury cars also made it difficult for him to come up with the cash he owed the IRS and meet other financial obligations, at least according to his former tax advisor, Samuel Levin, who sued Cage in 2009 for unpaid fees.
Cage, for his part, blamed his advisor for his problems, according to a CNN report. The actor has slowly been working to pay off the resulting $14 million tax debt. Dire financial straits may explain Cage’s recent string of “paycheck roles,” including the lead in 2014’s Left Behind, which earned a dismal 2% critic’s rating on Rotten Tomatoes and barely broke even at the box office.
4. Be cautious when deducting business expenses
“Only the little people pay taxes,” real estate and hotel mogul Leona Helmsley is reported to have said. And she meant it. Helmsley and her husband Harry may have been worth billions, but that didn’t stop them from engaging in numerous shenanigans to get out of paying taxes, including claiming personal expenses as business expenses. In 1987, the couple was indicted on tax evasion charges, with prosecutors asserting they had falsely claimed luxuries installed in their personal residences, such as a $1 million marble dance floor and a $210,000 mahogany card table, as business expenses. While the elderly Harry was deemed unfit to stand trial, Leona spent 18 months in prison and was ordered to pay a $7.1 million fine.
The lesson? While “ordinary and necessary” business expenses are deductible — and are a legitimate way for business owners to save money and reduce their taxes owed — if you go too far, the IRS will catch on and make you pay up.
5. Choose your tax adviser carefully
When singer Rihanna was hit with an IRS audit several years ago, she blamed the people she’d hired to manage her money. The Grammy winner sued her two accountants as well as their former employer Berdon LLP, alleging they had mishandled her finances. The 2012 lawsuit accused her accountants of not filing taxes on time, which led to late penalties, as well as withholding more money than necessary for both foreign and domestic taxes, which reportedly caused “a significant loss of tax benefits,” Reuters reported. Rihanna claimed her advisers’ missteps led to the IRS auditing her tax returns for 2008, 2009, and 2010. The suit was settled in 2014.
Not hiring the right professionals to manage her money was Rihanna’s big mistake. If you are going to hire someone to assist with your taxes or other financial matters, it’s important to vet them carefully, even if you’re not a millionaire pop star. Around tax time, the IRS urges people to be on the lookout for sketchy tax preparers, who may steal your identify, file fake returns, or claim inappropriate deductions. When the problems are discovered, the taxpayer is the one left holding the bag, even if they didn’t knowingly cheat on their taxes.
6. Remember to file
Forgetfulness is no excuse for not paying your taxes, at least in the eyes of the IRS, a lesson comedian Richard Pryor learned when he was fined and served 10 days in jail for failing to file tax returns. “I went to jail for income tax evasion, right?,” Pryor later said in a comedy routine. “I told the judge, I said, `You know, I forgot.’”
Depending on your situation, forgetting to file can lead to hefty penalties, wage garnishment, or losing out on a refund that was owed to you. So, if the April 15 filing deadline slips your mind, it’s best to promptly correct the mistake. “Regardless of your reason for not filing a required return, file your tax return as soon as possible,” the IRS urges. Taxpayers who need more time to file can request a six-month extension by filing Form 4868 by April 18.