CCH Points out Ten Tax Mistakes With Serious Consequences - From Back Taxes to Prison Time

1.

Not paying taxes on unemployment, wages, tips or other income – For 2009, the first $2,400 in unemployment benefits is excluded from income. However, beneficiaries are expected to pay taxes on the remaining benefits they received. Likewise, workers are expected to report all their income from work – whether it comes in the form of wages or tips. All investment income, including interest, dividends and capital gains, also is income and has its own tax ramifications.

2.

Inflating the value of charitable donations – While guessing is easier, and sometimes more profitable, 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 and non-cash donations of more than $5,000 must be appraised. Additionally, cash donations of any amount 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.

3.

Not reporting income from gambling or from illegal activities – Line 21 of Form 1040 is a bit of a catch all for reporting gains from various legal and illegal vices. So, whether a taxpayer had a profitable night at the casino or had earnings from illegal transactions, such embezzlement or other types of fraud, line 21 is where they need to tell all. In the case of ill-gotten gains, most crooks aren't likely to report this income, which is why they are often charged with income tax evasion when they're finally caught.  

4.

Chronic under-withholding of taxes – Generally, income tax follows a pay-as-you-go approach, meaning taxpayers must pay taxes on income they earn during the year it's earned. This is done through withholding or by paying estimated taxes on a quarterly basis. Under-withholding results in owing back taxes as well as a possible penalty. The penalty can be waived under certain circumstances, including, this year, under-withholding by employers due to the Making Work Pay Credit. People generally try to avoid under-withholding by making sure they pay at least as much as they paid in taxes the previous year or by paying through withholdings or estimated taxes 90 percent of what was owed for the current year.

5.

Non-authorized use of the First-time Homebuyer Credit – Treasury Inspector General for the Tax Administration J. Russell George told the House Ways and Means Committee that tens of thousands of ineligible taxpayers may have claimed the credit so far. These include:

• Nearly 74,000 claims by taxpayers who had indication of prior home ownership, for example, had claimed mortgage interest deductions or real estate taxes on previous tax returns;

• Approximately 19,300 taxpayers who claimed the credit for a future home purchase; and

• More than 580 taxpayers younger than 18 years of age who claimed the credit.

6.

Exaggerating business expenses – The IRS is well aware of abusive tax schemes where taxpayers inflate business expenses or attempt to write off personal and family expenses under the guise of a home-based business – where either no business exists or the deductions are clearly invalid, as they are not related to the business. For expenses to qualify as business deductions, they must be ordinary and necessary expenses paid or incurred in carrying on a trade or business.

7.

Not filing a tax return – Ever since the enactment of the federal income tax in 1913, people have challenged the tax on various grounds. However, these challenges are consistently unsuccessful and most people are required to file a federal income tax return. Not filing a tax return when required is considered income tax evasion with penalties including paying back taxes, interest, possible fines and potentially serving a prison sentence in the most serious cases.

8.

Not paying taxes on household help – Taxpayers who have a nanny or other household workers are required to withhold and pay FICA taxes if cash wages paid in 2009 totaled $1,700 or more. They also 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 their Form 1040 or 1040A. Taxpayers with household workers may also want to consider paying the tax on a quarterly basis by having an additional amount withheld from their salary or by making a bigger quarterly estimated payment to ensure they are not underpaying taxes, which would subject them to additional penalties.

9.

Not reporting gifts given over $13,000 – Taxpayers giving gifts in excess of $13,000 in 2009 as a single filer or $26,000 as a split gift by joint filers have one of two options to satisfy their tax obligation. They can either pay taxes on the amount above this limit or apply it against their 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. Not reporting the gift is considered tax evasion. Gifts are reported on Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return.

10.

Not paying taxes on income earned from offshore accounts – In March 2009, the IRS announced special provisions to allow taxpayers to voluntarily disclose unreported income held in hidden offshore accounts. Under the provisions, taxpayers who came forward would be able to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. The special provisions expired October 15, 2009. Nearly 15,000 Americans living and working in more than 70 countries came forward. Taxpayers who have not come forward and are subsequently detected by the IRS will face significant penalties and increased risk of criminal prosecution.