Everyone wants to save on taxes, and some people are even willing to break the law to do so. These individuals aren’t content with trimming their IRS bill in legitimate ways, such as by putting money in a 401(k) or deducting charitable contributions. They also employ dubious tax-saving strategies designed to fool the IRS into thinking they owe less tax than they really do.
The IRS keeps a close eye out for these tax cheats, who cost the government billions in lost revenue. Every year, the agency also issues a list of the “dirty dozen” tax scams to warn consumers of illegal tax-related activities. Many of the scams involve criminals taking advantage of innocent taxpayers. A con artist might steal someone’s Social Security number and use it to file a false return, for example, or someone might impersonate an IRS agent over the phone in order to trick someone into revealing personal information.
A few scams, however, are perpetrated by taxpayers themselves, sometimes with the help or encouragement of their tax advisers, financial advisers, or lawyers. These scams can involve deliberately lying about income, intentionally claiming inappropriate deductions, and making up ridiculous arguments to get out of paying taxes. Get caught pulling one of these tricks, and you could be on the hook for big penalties and may even be charged with a crime, even if it was your tax preparer who came up with the scheme.
“Misrepresenting facts is cheating and taxpayers are legally responsible for all the information reported on their tax returns,” IRS commissioner John Koskinen noted.
To avoid finding yourself in the IRS’s crosshairs, be sure to avoid these five tax scams.
1. Lying about your income
Inflating your income might seem like a weird way to save on taxes, but some people do this as a way to claim more refundable tax credits, according to the IRS. In the case of the earned income tax credit, for example, the size of the credit increases with your income (up to certain limits), so saying you made more than you really did nets you more back from the government. Dishonest or misinformed tax preparers may actually encourage you to engage in this scam, one reason why it’s important to choose a trustworthy, experienced person to help you with your return.
Underreporting income to save on taxes is also a dumb move. The IRS is able to compare the information on your tax return with information from your employer and financial institutions. If there’s a discrepancy, expect the IRS to be in touch.
2. Padding deductions
Don’t give in to the temptation to say you donated more to charity than you really did last year, inflate your gambling losses, or claim some personal expenses as business expenses. Suspicious deductions, like saying you use half of your home for business purposes or claiming large non-cash charitable contributions, could raise a red flag with the IRS.
“Taxpayers who have excessive deductions, (or) unreasonable and questionable expenses are likely to trigger an audit,” Carl Johnson, a certified public accountant, told Bankrate. Even if your deduction is legitimate, make sure you can back it up with receipts or other documentation to avoid a big tax headache.
3. Using abusive tax shelters
Sketchy investments designed solely to reduce the income tax you owe are a big no-no. These tax avoidance schemes are often quite complex, and might involve misusing trusts or employing multiple flow-through entities to try to hide who owns the assets, according to the IRS. If the primary selling point for an investment is a promise to eliminate your tax liability, be cautious. Too-good-to-be-true investments and financial tricks are often just that.
“Taxpayers should steer clear of unscrupulous promoters who sell phony tax shelters with no real purpose other than to avoid paying what is owed,” Koskinen said. “These schemes can end up costing taxpayers more in back taxes, penalties, and interest than they saved in the first place.”
4. Hiding money in offshore accounts
For years, people have tried to avoid paying taxes by hiding their money in tax havens around the world. Recently, the IRS has cracked down hard on this form of tax avoidance. Many foreign banks and financial institutions now report information on possible U.S. tax avoiders to the IRS, which makes it more difficult to use this trick to get out of paying the IRS.
While there are perfectly legitimate reasons for an American taxpayer to have offshore accounts, the penalties you’ll pay for not following proper reporting requirements are among the stiffest the IRS levies. If you deliberately fail to tell the IRS about an offshore account, you could be forced to hand over between 50% and 100% of the account balance.
5. Making frivolous tax arguments
You might not like paying taxes, but you have to do it. Yet some people will present all kinds of bizarre arguments for why they don’t have to send their money to the IRS. These tax avoiders may try to argue that paying or filing taxes is voluntary, that their religion prohibits them from paying taxes, that they are a citizen of a state, not the United States and thus not subject to taxes, or that paying taxes is a kind of slavery and therefore prohibited under the Thirteenth Amendment. All of these arguments (and many more) are bunk.
Don’t think you can beat the IRS at its own game. The penalty for filing a frivolous tax return is $5,000. You could also get hit with other penalties for failing to file or filing an inaccurate return, and may even be charged with a felony. Just ask actor Wesley Snipes, whose frivolous anti-tax arguments eventually landed him in prison.