Tax Fraud

IRS examinations can take different forms; from a computer algorithm, a letter audit asking for information, or a full-blown in-person audit. During the process the IRS will be keenly aware that fraud may exist. When indicators (badges) of fraud are uncovered, the matter is serious enough to immediately involve management and technical advisors as the case for fraud is developed. The taxpayer now has the full attention of the most powerful collection agency in the United States.

Allegations of fraud by the IRS could not be more serious. The penalty for civil fraud is 75% of the tax that was not paid (plus interest), and in cases of criminal fraud, the penalty is 100% of unpaid taxes, interest, and possibly jail time. Criminal fraud is often referred to as tax evasion, especially when the fraud involves the willful and intentional concealment of income.  

Most cases of fraud are smaller civil cases because proving willful and intentional criminal fraud is difficult. A typical example of civil fraud might be something like a construction contractor who fails to report 1099 income; we had a case like this once. His payer issued a form 1099-MISC reporting about $110,000 of gross income. The IRS got their carbon-copy of the 1099, but because the contractor had moved, and failed to forward his mail, he didn’t get his copy. Since he did not get a 1099 he must not be responsible to report that income, right? The answer is that, 1099 or not, you are responsible for reporting all of your worldwide income.

In this case the IRS re-computed the tax and added the 75% civil fraud penalty with interest. Because he was basically caught red-handed, the only thing we could do was amend the original tax return to at least include business expenses, and protect his rights. The tax owed was about $22,000, add the 75% penalty at $16,500, other smaller penalties, and interest that started at April 15, and the liability was about $44,000.

Assuming that your business and family survive this blow, it can take as long as 10 years to recover from a pitfall like this. If something like this happens to you, or the IRS is proposing a charge of fraud, this is the time to seek out professional help and it needs to come from a licensed tax professional. In many instances where the IRS proposes assessing fraud penalties, there are options, such as reasonable cause. We can help.

Never co-mingle bank accounts

If you have a business then that business needs its own bank account. Often times, when I meet a new business owner, I have to explain the importance of having a separate bank account. Not only does it make your bookkeeping easier, it creates a legal distinction between you and the operations of the business. Once you have separate accounts you need to insure that they are never co-mingled. What belongs to the business stays in the business and only legal distributions and wages end up in your personal account. If you have your own corporation, which is an individual person in the eyes of the law, don’t you thing that person would want their own bank account?

In a recent tax court memo an S corporation with one owner was skewered by the IRS because they co-mingled business income with personal funds by making deposits of gross receipts into their corporate account as well as their two personal bank accounts. That is called co-mingling and is not allowed. The IRS takes a very dim view of co-mingling because it is a tactic used by people who are trying to hide nefarious activities.   

To make things worse, the owner substantially omitted greater than 25% of his corporate gross earnings from his business return. This omission gave the IRS the legal authority to use the six year look-back period for audits instead of the usual three years. Normally the IRS has three years after a tax return has been filed to open up the books for an audit, but if you break certain rules, they can go back an additional three, which is what they did in this case.

The owner gave three separate sets of bank statements to their accountant; the corporate account and two personal accounts. The owner had deposited business income to all three accounts effectively co-mingling gross receipts. The accountant only reported the gross receipts from the business bank account in their bookkeeping calculations. One might deduce that willful blindness played a part but the IRS tends to focus on facts it can prove; that the business owner failed to report the correct amount of gross income to his corporation. Chasing a charge of fraud is difficult because proving intent is an uphill battle. So the IRS appears to have taken the bird in the hand and ignored what may have been lurking in the bush.

Keep your business activities separate from your personal dealings and never co-mingle the two. A first step for any new businesses is to get a separate bank account. If you do not fully understand these concepts then seek out a consultation from your friendly licensed tax practitioner. Using a licensed practitioner is important as it is unlawful for an unlicensed tax preparer to advise in any matter that is not directly connected to the tax returns they work on.

When the IRS files a tax return for you

When the IRS prepares a return for you they call that an Automated Substitute for Return (ASFR). It is an assessment tool intended to enforce compliance for those who are delinquent in filing their tax returns. Generally it is used to systematically calculate tax liabilities so that the IRS can commence with collections actions.

I have met people who never file their tax returns but they also never hear from the IRS. They are wrong in thinking that the Government is not paying attention to them. The reality is that if they never hear from the IRS it is because they are due a refund. For the record, the IRS also gets copies of any payee statements that you get; so they know.

If the only record the IRS has for you is a copy of your W-2, calculating tax based only on the W-2 is easy enough that it is done by machine. You don’t hear from the IRS because the IRS has made the calculation and they know that you are due a refund. The IRS has no reason to send you a notice because you don’t owe any tax. A refund for a tax return can not happen until the tax return is filed.

Conversely, after the IRS has your W-2s, 1099s, or other payee statements, and it turns out that you owe taxes, they will want to collect. They will start with reminder notices and go from there. If you fail to respond to the reminders and proposals, the IRS will eventually file a Substitute tax return (ASFR) for you so that they can commence with collecting that tax due for that return. Your tax return then goes to the IRS Collections department, and subsequently the Balance Due department, and those actions represent escalations in enforcement. But is the tax they are after the right amount?

You are not on this earth to unjustly enrich the Government. Yes – you can still file your back tax return(s). You need to get that tax return filed because the IRS may not have all of the adjustments and deductions that you are entitled to. After a seasoned tax pro sorts things out, you may even be entitled to a refund. Under certain circumstances you may be entitled to apply for abatement of the related penalties. Or, you can just roll over and pay the tax.

If you are behind in filing your tax returns contact our firm for help because there is a good chance that you may be due some refund money. 

The IRS Streamlined Installment Agreement

That means having your installment agreement processed in a streamlined manner compared to providing a stack of financial information going back three months.

If you owe taxes to the Government and can not pay right away, the Internal Revenue Service will generally allow you to enter into an agreement to pay in installments over time. You will incur interest and penalty expenses. There is a setup fee and that can vary. Short term plans are for 120 days or less, and the longest you can go is 72 months (although the IRS is testing terms that go out to 84 months). Sometimes a tax lien is filed against the taxpayer to protect the Government’s interest. Tax liens, depending on the taxpayer’s history, can be filed for any amounts. The payment amounts generally must be enough to pay the entire debt within the time frame agreed upon, but there are exceptions.

There are general categories for installment agreements (IA) based on how much money you owe; less than $10,000, less than $25,000, between $25,000 and $50,000, and over $50,000. Generally an IA for an individual (no businesses or trusts) who owe $10,000 or less is guaranteed; it is there for the asking. Taxpayer’s who owe less than $25,000 generally qualify for an automatic streamlined agreement. Taxpayer’s who owe between $25,000 and $50,000 may qualify for an automatic streamlined agreement but if they have had problems in the past, the IRS may insist on either partial financial information, or complete financial information with a financial statement. If you owe more than $50,000 expect to produce a financial statement and three months of bill copies representing necessary living expenses.

A complete discussion of these matters is well beyond the scope of this blog. There are very many laws that pertain to collecting taxes, and for every law there is generally an exception. As such, collections matters can be mind-boggling. If you find yourself in trouble, don’t go it alone because you need competent and licensed professional representation.   

Can the IRS put me in jail?

Yes, but never for owing taxes. The IRS can criminally prosecute you and possibly put you in jail if you voluntarily and deliberately violate a known legal duty in order to avoid paying taxes. That would be tax fraud (sometimes called evasion). However, if you do everything right, and find yourself in a bind because you can not pay a tax, you will have collections problems but you will not go to jail.

Tax fraud is the deliberate and willful attempt to evade tax law or defraud the IRS. Fraud, as defined by the IRS, “Is the deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it. Simply stated, is the obtaining something of value from someone else through deceit,” IRM 25.1.1.2.

The criminal fraud penalty requires the IRS to prove intent and this penalty is 100% of the tax owed plus interest. Because intent can be difficult to prove, in many smaller cases the IRS will often opt to assess a Civil Fraud Penalty instead. The Civil Fraud Penalty is 75% of the tax owed, plus interest. Imposing a penalty for Civil Fraud is much easier for the IRS to impose and generally results in the same outcome; to punish an infraction and encourage future compliance.

If you are threatened by the IRS with these sorts of allegations, contact us because we can help. 

Did you know that the IRS generally has 10 years to collect taxes?

It is called the Collection Statute Expiration Date (CSED). That is the expiration of time period established by law that the IRS has to collect a given tax. Once a CSED expires the IRS will write it off.

Assume that you filed your 2017 form 1040 on time on April 18, 2018. You owed taxes for that return that you did not pay. All things being equal, after April 19, 2028 the IRS can no longer lawfully collect that tax and you are off the hook.

A CSED starts only after a tax return has been filed. The CSED does not start automatically on the due date. If a taxpayer filed their 2017 tax return on June 1 of 2020 that is when their 2017 CSED will start. If there are no tolls on the CSED, on June 2 of 2030 the IRS can no longer legally come after that 2017 tax.

The CSED can be tolled, or stopped, by different collections and legal actions, so it is not always easily defined. Because a serious IRS collections matter will take years to resolve, and the taxpayer and their representatives will try different strategies for relief, it is typical for a CSED to be tolled and re-computed. Some actions that toll a CSED are: Collection Due Process Cases, being in a Disaster Area, Military Postponement, Bankruptcy, Offer-in-Compromise, Installment Payment Agreement, Summons Enforcement, Taxpayer Assistance Order, and Innocent Spouse. When a taxpayer is in any of these situations, the CSED changes and will need to be re-computed.

Sometimes a taxpayer owes more than one type of tax, and for more than one period; businesses have multiple due dates throughout a given year. You can imagine how complicated calculating any CSED can get when a taxpayer falls a couple of years behind. You will need the help of a licensed professional if you plan to use the CSED as part of a larger strategy.

Did you know that the IRS has a first time penalty abatement?

If you qualify, you can receive administrative relief from penalties for failing to file a tax return, pay on time, and/or to deposit taxes – no questions asked.  

The most common IRS penalties are for failing to file (on time), and failing to pay (on time). If you owe federal income tax, your tax return as well as the payment, is due by April 15. You can extend your time to file until October 15, but that is never an extension of time to pay. If you fail to pay by April 15 you will incur the failure to pay penalty. If you do not file by your deadline you will incur the failure to file penalty. It is common for delinquent taxpayers to have both penalties assessed against them.

If you have three years of clean tax history immediately prior to your trouble year, you filed all currently required returns or filed an extension, and you have paid, or arranged to pay, any tax due, you may qualify for automatic administrative relief from the penalties.

If you are usually on time with your tax returns and payments and had this one bad year that is when you need to remember this lesson. As tax returns become more complex, and the amounts of money involved get bigger, there will be a number of elements that need checking. If you are not sure if you qualify, contact our firm for help.

Trust fund penalties revisitied

If an employer fails to properly pay its payroll taxes, the IRS can seek to collect a trust fund penalty equal to 100% of the unpaid taxes from any person who is considered a “responsible person,” (One who is responsible for collecting, accounting for, and paying over payroll taxes); and also willfully fails to perform this responsibility. The IRS will often assess these penalties against any and all persons in the organization who can be considered “responsible persons.” 

To determine who a responsible person is, several factors are considered: (1) the duties of the officer as outlined by the corporate by-laws; (2) the ability of the individual to sign checks for the corporation; (3) the identity of the officers, directors, and shareholders; (4) the identity of the individuals who hire and fire employees; and (5), the identity of the individuals who were in control of the financial affairs of the corporation. Other factors include whether the person had access to the company’s books and records, and whether the individual has made personal loans to the company. Other intricacies, and there are many, are beyond the scope of this article.

A responsible person will be found liable under the Code if the IRS can demonstrate that they had either (1) actual knowledge that the trust fund taxes were not paid and the ability to pay the taxes, or (2) recklessly disregarded known risks that the trust fund taxes were not paid. In other words, they knew that the taxes had not been paid, and had access to the funds to pay the taxes, but willfully chose to pay other liabilities instead.

Trust fund taxes are the portion of the payroll tax that is withheld from an employee’s wages; income tax, social security tax, and Medicare tax. Because social security and Medicare are trust funds, an employer has a fiduciary responsibility for properly managing these monies. The portion of payroll taxes that are “matched” by the employer are not trust fund taxes, but are still a tax liability for the company.

For a business having trouble with its cash flows, not paying over these taxes can be the easiest loan to take out, and the hardest loan to pay back. The owners typically figure, “I’m short on money this month, but things will be better next month and I’ll pay the taxes next month.” Next month comes, cash flows are no different, and down the slippery slope the business goes. Maybe the next month is back to normal, but not good enough to pay two months’ worth of payroll tax, so the owner pays last months tax and puts off paying the taxes for the current month. Kiting the payment of payroll taxes is such a common occurrence that the IRS and their algorithms specifically look for these patterns.

If you think that the IRS has no sense of humor when it comes to unpaid income taxes, just wait until you get behind with somebody else’s trust fund monies; especially when those employees have applied for, and received their income tax refunds – of tax money that was never paid in. If you own a company, are behind in your payroll taxes, and take a wage, be careful because if you claim a refund for taxes that were never paid in that is considered fraud. The penalty for civil fraud is 75% of the tax owed. If you are having troubles like this, contact our firm right away so that we can help stop the bleeding and pull you out of this pitfall.

IRS intends to increase fees for installment agreements

IRS intends to increase fees for installment agreements

If you owe the IRS money and can't pay it right now they will agree to allowing you to pay in installments, just so long as you can pay off your debt within 72 months. There is a user fee to establish an IRS Installment Agreement.

Proposed regulations will increase the current user fees from $120 ($52 for taxpayers who agree to an automatic bank debit), to $225 ($107 for taxpayers who agree to the automatic debit).

IRS to begin using private debt collectors

IRS to begin using private debt collectors

The IRS announced that it would begin using private debt collection agencies some time next spring.

This change in methods is a result of legislation enacted by Congress last December.  The plan is to use these agencies to work on accounts that the IRS is no longer working on. The IRS will alert taxpayers and their representatives prior to assigning the account to the private debt collector.

Community property laws and taxation

There are nine community property states; Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Generally, if you are domiciled in one of these states, and your tax filing status is Married Filing Separate, your MFS tax return will reflect exactly half of the combined income from both you and your spouse, despite whomever earned it.

As with any other law there are exceptions. Regardless of the general IRS rule that community income be shared equally, and taxed in equal proportions for each spouse, there are circumstances where community income can be segregated and assigned only to the spouse who earned it. This is an important concept to anyone who has, or is planning on a divorce, and lives in one of the community property states.

If your spouse had income for a year, you did not live with them for that year, and they did not share any of that income with you, then there are ways to segregate yourself from the Federal income tax on that income which you were prevented from benefiting from. Contact one of our offices or your licensed tax professional for advice if you think this situation applies to you.

Offer in Compromise fee to increase

The user fee for processing an Offer in Compromise application may increase from $186 to $300. If the proposed IRS regulations are implemented, the increased fee would apply to any Forms 656 submitted on or after February 27, 2017.

Applicants who can prove that their household monthly income is at or below the low-income threshold for the size of their family, may qualify to have the application fee waived.

Attention all Tax Whistleblowers!

If you are considering turning whistleblower in the hopes that you will get a reward, the process may not be as easy as you thought. You will want to use Form 211. The form and instructions are available at irs.gov.

Consider that the IRS has discretionary authority under Code Sec. 7623, to determine your reward of 15-30%. Your reward depends on two major factors; the reward must come from proceeds that are collected, and that those proceeds must be attributable to the information you provided.

The IRS is not always able to collect the amounts owed if they are able to collect at all, and unless the information you provide is specific, you may end up contributing but not to the extent necessary to receive a reward. Contact our office if you need help with one of these matters because the advisory fees you pay up front to meet with a CPA and Attorney might make all the difference.