Last Updated: December 3, 2009
"Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." So said Learned Hand, who is regarded as one of the finest jurists in American history.
But in trying to arrange your affairs to pay the least amount of taxes, there's often a fine line between blunders and evasion, according to a recent release from CCH, a Wolters Kluwer business.
Indeed, consider the recent case of Treasury Secretary Timothy F. Geithner, whose nomination to that post hit a snag during confirmation hearings. According to published reports, Geithner disclosed that he had failed to pay more than $34,000 in federal taxes over several years early this decade. What's more, Geithner faced questions about the employment papers of a former household employee. Obama transition officials said Mr. Geithner's failures were innocent mistakes or technicalities and Geithner's nomination was ultimately approved.
"Sometimes, people truly do make mistakes and the International Revenue Service (IRS) can be reasonable about these types of oversights, but when an individual is seen to be deliberately or repeatedly evading their tax obligations, the consequences can be very stiff," FPA member Mark Luscombe, JD, LLM, CPA, Principal Federal Tax Analyst of CCH Incorporated said in a release.
Luscombe, who has lectured in FPA's Virtual Learning Center, reviewed in that same release 10 tax blunders that cross the line from tax avoidance to tax evasion. Here's a look at that list and some other blunders as identified by FPA members.
Not reporting gambling income. If you receive money, prizes or awards of monetary value from winning the lottery, you are required to report this as income. Losses also are deductible, but only to the extent of the taxpayer's gains from similar transactions.
Not paying taxes on unemployment, wages, tips or other earned or unearned income. If you are out of work and receiving unemployment benefits, you have to pay taxes on the benefits. You either can instruct your state unemployment agency to withhold the taxes similar to how you would instruct your employer to withhold from a paycheck, or you have to pay quarterly estimated taxes on it.
Inappropriately reporting children's investment income. A child's investment income of more than $1,900 must be reported on the parent's income tax return and taxed at the parent's income tax rate if the child was under age 18 at the end of 2009, was 18 years old at the end of 2009 and did not have earned income that was more than half the child's support, or the child was a full-time student, 19 to 23 years of age and did not have earned income that was more than half of his or her support. You need to use Form 8615 to figure out the tax for a child's investment income.
Not paying the nanny tax. If you have household workers, you are required to withhold and pay FICA taxes if cash wages paid in 2009 totaled $1,700 or more. As the employer, you have to report and pay the required employment taxes for these domestic employees on Schedule H (Household Employment Taxes), with the tax amount then transferring to the appropriate line on your Form 1040 or 1040A.
Not reporting gifts given over $13,000. If you gave a gift to an individual in excess of $13,000 in 2009 as a single filer or $26,000 as a split gift by joint filers, you either have to pay taxes on the amount above this limit or apply it against your lifetime gift tax exemption (which currently is $1 million). The tax on gifts ranges from 18 percent on taxable gifts below $10,000 to 45 percent on gifts of $1.5 million or more. If you don't report the gift, it is considered tax evasion. Gifts are reported on Form 709.
Being overly charitable to oneself with charitable donations. The IRS expects people donating items to use fair market value in determining the value of the items; for non-cash donations of more than $500 a written description of the donated property must also be furnished. Additionally, cash donations of any amount now require proof, such as a cancelled check, credit card statement or receipt from the charity. Contributions of $250 or more also require a letter from the organization specifying the name of the donor, the amount given and the date received.
Exaggerating expenses. Taxpayers who don't have proof of expenses they are deducting will be required to pay back taxes and interest on non-substantiated deductions. Depending upon the extent of abuse, the IRS may take other measures as well.
Not filing a tax return. Most people are required to file a tax return and even those who are not can benefit from doing so. For example, by having the chance to get a refund on taxes already withheld or to claim the earned income credit, additional child tax credit, first-time homebuyer credit or the recovery rebate credit. Income thresholds for those who must file range based on age and filing status. For single filers under age 65, returns must be filed if they earn $9,350; returns must be filed for married couples under age 65 filing jointly if their income is $18,700 or more. Tax returns are due on April 15. Taxpayers can file for an extension until October 15, but they must file the request (using IRS Form 4868) for an extension by April 15.
Filing an incomplete tax return. For most people, making an error on their tax return or not completing it means a delay in any refund they may have coming and additional inquiries from the IRS. They may also be subject to additional payments and interest if it's determined they owe more taxes. However, if the IRS determines someone is intentionally filing an incomplete or inaccurate return, this is tax evasion and the IRS will pursue it as such.
Doing your own tax return. Preparing your own tax return — no matter whether you use software or not — isn't a blunder per se. But doing so does increase the odds of making a mistake Treasury Secretary Geithner discovered. If you do use software to prepare your taxes, make sure you have a financial professional review your return for errors. "Software is terrific but some things get missed, errors are made," said FPA member Larry Botzman, CFP®. "Capital gains get reported as income, basis is miscalculated for gains and dividends which have already been taxed."
If you prepare your own tax return but don't use software, FPA member Christopher Lee, CFP®, of New England Capital Financial Advisors cautioned against making this mistake: forgetting to complete and include Schedule D with your tax return. You use Schedule D to report your realized capital gains or losses.
Failing to learn from the past. It's one thing to have your taxes prepared by a financial professional. "But it would be a mistake if you failed to ask that professional to analyze your tax return for ways to reduce your tax bill going forward," said Botzman. You could, for instance, examine when it might be worth itemizing deduction or simply taking the standard deduction at retirement.