Get a game plan together to conquer your debt

When you are struggling to balance the budget, credit cards gives you a helping hand. But if you keep doing it month after month, very soon your debt load will go over your head. Credit card companies realize this and they will keep increasing your credit limit if you are a worthy customer. This is a habit that many of us need to break and to do that you need to get a game plan together to get out of debt and create even some savings.

Credit counselors call this a credit management plan. If you stick to the plan, you can get out of debt within a specified time period and will require a certain monthly payment level to be maintained. But the plan and the counseling could help you to lower your interest payment on credit card balances. Savings from interest will help you to come up with higher monthly payments. Plan will help you to avoid considering disastrous bankruptcy and other extreme measures. Once the debt loads starting to go down and no new debt accumulating, your credit score will start to climb again. When the debt is paid off, you can begin to build a nest egg for a rainy day.

How People Cheat on Their Taxes

Most cheating is from deliberate—actual or willful—underreporting of income. This is called tax evasion—the most commonly charged tax crime. A government study found the most underreporting of income was by self-employed restaurateurs, clothing store owners, and—you’ll no doubt be shocked—car dealers. Telemarketers and salespeople came in next, followed by doctors, lawyers (heavens!), accountants (heavens, again!), and hairdressers.

Business owners who over-deduct business-related expenses—such as car and entertainment—came in a distant second on the cheaters hit parade. Surprisingly, the IRS contends that only 6.8% of deductions are overstated or just plain phony.

If You Are Caught Cheating

Tax crimes are most likely to be first spotted during an audit. If you are caught in a tax lie by an auditor, she can either slap you with a penalty or refer your case to the IRS’s criminal investigation division (CID). In the vast majority of cases, the auditor won’t call in the CID.

The Auditor Suspects You of Fraud

Auditors are trained to look for signs of tax fraud, which is a form of tax evasion. Tax fraud is defined as a willful act done with the intent to defraud the IRS—that dark area beyond honest mistakes. Using a false Social Security number, keeping two sets of financial books, or claiming a blind spouse as a dependent when you are single are all blatant examples of tax fraud. While auditors look for fraud, however, they do not routinely suspect it. They know the tax law is complex and expect to find a few careless mistakes in every tax return. They will give you the benefit of the doubt most of the time.

Even if the auditor does not refer suspected fraud to the CID, she can impose fines, called civil penalties, if you omitted a chunk of income on your tax return. Overstated or phony deductions and exemptions can also be punished by the fraud civil penalty—for example, claiming exemptions for dependents who have long since left home, died, or were never born. Fraud penalties can also be added for exaggerating deductions, such as adding a zero to $200 making it $2,000, or by claiming a casualty loss for a nonexistent accident.

Fraud or Negligence?

A mistake on your tax return might get you a 20% penalty tacked on to your tax bill. While not good, this sure beats the cost of tax fraud—a 75% civil penalty. The line between negligence and fraud is not always clear, however, even to the IRS and the courts.

Auditors are trained to spot common types of wrongdoing, called “badges of fraud.” Examples include a business with two sets of books or without any records at all, freshly made false receipts, and checks altered to increase deductions. Altered cancelled checks are easy to spot by comparing written numbers with computer coding on the check or bank statements.

The Internal Revenue Manual directs auditors suspecting criminal tax fraud to contact the IRS criminal investigation division, or CID. In reality, auditors make very few criminal referrals. Making a fraud referral is too much paperwork. If auditors find a couple of obviously phony receipts, they usually will quietly disallow them and move on. Fraud referrals are more often made in special project audits. These are targeted audits of particular industries and professions, such as building contractors or chiropractors.

caution

The auditor will not tell you if she has made a criminal fraud referral. One indication, however, may be an audit stopping midstream for no apparent reason. But never assume a fraud referral was made just because months pass and you don’t hear from the auditor. She is probably just behind in her work.

Indirect Methods of Proving Fraud

Direct proof of fraud by the IRS typically consists of finding clearly overstated or phony deductions and exemptions. Direct proof is not usually found by the IRS for income underreporting. Instead, the IRS relies on primarily four indirect methods.

Specific items. If you cashed a check received by your business and pocketed the money without entering it in your books, this check is a “specific item.” It can be viewed as evidence of fraudulent intent. If the auditor suspects fraud, she may talk to your business’s customers to compare your bank account deposits and actual payments you received from customers.

The IRS wants more than just one specific item to make a fraud case—unless the item was for many thousands of dollars. While you might argue that one or two items were negligently left off the books (or your computer crashed or you lost your records), 15 or 20 omitted items shows a pattern of fraud.

Bank deposits. This is the IRS’s favorite indirect method to prove unreported income, because it is so easy. The auditor simply adds up all deposits in your bank accounts. If the total exceeds your reported income, you may be suspected of fraud.

There may be a perfectly legitimate explanation, such as nontaxable sources of bank deposits—loans, gifts, inheritances, sales of assets, and tax-exempt income, such as municipal bond interest. Also, transfers from one bank account to another appear to be multiple deposits under this simplistic method. Point this out to the suspicious auditor. Or, deposits in your accounts may belong to relatives or friends who did not use their own accounts for some reason.

Expenditures. The auditor calculates your living expenses by totaling up the credit charges you paid, checks you wrote, and adding known or estimated expenses you paid by cash. If the total is greater than your tax-reported income, the auditor will suspect fraud. Auditors can refer to statistical reference books showing average costs of various necessities such as food and shelter in your community.

To counter this, explain where you got the money to pay your bills. It could be savings from prior years, selling assets, or receiving loans or gifts. To figure your living expenses, auditors often ask you to complete IRS Form 4822, Statement of Annual Living Expenses.

tip

Never fill out IRS Form 4822 listing your living expenses. Just say you didn’t keep track of every penny you spent for the year and don’t want to guess. Or, diplomatically tell the auditor you will consider it and then throw the form away. The IRS cannot punish you for refusing to fill out this form. If an auditor is intent on proving fraud, he will do it with or without your cooperation. Don’t do his job for him.

Net worth. Under this indirect method, an auditor adds up all of your assets and deducts all of your liabilities at the start and end of the tax year under audit. If there was an increase in your net worth—what you own minus what you owe—without an increase in income from the previous tax year, you may be suspected of fraud.

Again, there are many valid explanations as to how your net worth can increase besides unreported income. For example, you may have received nontaxable gifts or loans or inheritances. Or the auditor may have mistakenly included appreciation in his calculations.

Penalties for Civil Tax Fraud

You will probably never face criminal fraud penalties. At least 98% of the time, the IRS punishes fraud with civil penalties—fines of 75% added to the tax due. For example, if the additional tax due from fraud is $10,000, the penalty is $7,500, for a total of $17,500. Interest is added on to both the tax and the fraud penalty, starting on the date the return was due or filed, whichever is later.

Defending Against Alleged Tax Fraud

The three defenses most often raised against tax fraud allegations are cash hoard, nontaxable income, and honest mistake. Don’t expect the IRS to accept any of these defenses at face value. A skilled attorney is better able to persuade the IRS than you are. Combatting tax fraud, like brain surgery, is not a do-it-yourself project.

I lived off my cash hoard. This defense can be raised whenever the IRS uses the bank deposits, expenditures, or net worth methods of proving fraud. There is no law (not yet, anyway) against having cash of any amount buried in your back yard or kept in a safe deposit box. The IRS’s only legitimate concerns with your cash holdings are whether or not it was from taxable income, and if you reported it and paid tax on it. The IRS understandably is suspicious of people who hold large amounts of cash rather than putting it in an interest-bearing account.

I lived off a nontaxable source. The receipt of money is not always taxable income, as discussed above. You may innocently acquire tax-free wealth by gift, loans, inheritances, and other ways. This defense can be coupled with the cash hoard defense.

I made an honest mistake. If you make an error on your tax return, it is not necessarily fraud. For example, you didn’t report profit from a sale of investment real estate because you believed you had two years to reinvest the proceeds without tax consequences. In reality, the law only allows you 180 days. Because intent to cheat the IRS is required for fraud, your mistaken belief is a valid defense to a tax fraud charge—but you may have to convince a judge or jury that it really was a mistake.

caution

Don’t try to lie your way out of a fraud charge. If in doubt, keep your mouth closed. Lying to the IRS can make matters worse. The right against self-incrimination is guaranteed by the Fifth Amendment. You have the absolute right to remain silent before the IRS whenever there is a possibility you may be charged with a crime. Lying to an IRS employee can result in a felony conviction with up to three years in prison and a $100,000 fine.

Options When the IRS Finds Fraud

If an IRS auditor believes you’ve cheated on your taxes, she has several options.

Ignore the cheating. If the amount is small, an IRS auditor will overlook it. Typically, an auditor just wants the file closed and off her desk—particularly if she has found other significant adjustments. She will likely leave it at that and never refer your file to the CID.

Impose civil penalties. IRS auditors draw the line at outrageous cheating. Most will add civil, as opposed to criminal, penalties on to your tax bill, especially if your case is deemed too small to send to the CID.

In the case of small mistakes, an auditor can add a 20% penalty to your bill if she finds that your tax error was “accuracy related.” If she concludes you owe an additional $1,500 of taxes, she can add a penalty of $300, bringing the bill to $1,800. The IRS imposes civil penalties about 25 million times each year.

If the auditor finds more serious misdeeds, however—particularly if your omission or overdeduction was fraudulent—she could add a 75% penalty, bringing your $1,500 tax bill to $2,625. And, interest will be added to both the penalty and the taxes.

Begin a criminal investigation. If the IRS suspects that you have gone too far, the CID can investigate.

The CID usually gets information that leads to an investigation from one of the following sources:

• referrals from other IRS divisions, most often from auditors who discovered unreported income during an examination
• tips from law enforcement agencies —the IRS isn’t concerned with the nontax crime itself, often a drug-related offense, but whether or not the illegal income was reported.

Example:

When Morgan was arrested for suspected drug trafficking, $150,000 in cash was in his car’s trunk. After his arrest, the local police notified the IRS. The CID looked at Morgan’s last few tax returns, where he reported only $35,000 of income per year. The CID immediately began a formal investigation.

• tips from citizens—Ex-spouses or disgruntled employees and business associates often contact the IRS. These people are called squeals. The CID usually follows up only on well- documented tips. Many allegations are not provable and are motivated by spite, and the CID doesn’t waste its time on them. It may refer the case to the examination division, however.
• IRS undercover or sting operations—CID agents often pose as buyers of businesses to find off-the-books income. Unwary sellers who brag about second sets of books and how much cash the business takes in get nailed. Other undercover operations investigate gross discrepancies in reported income and a taxpayer’s lifestyle. This is how the U.S. government finally got Al Capone!

Example:

Roy owned a rather seedy looking pawn shop and was featured in a local newspaper article on successful businesspeople. Roy proudly posed for the paper in front of his waterfront home and Rolls Royce. Soon thereafter, Roy was audited. The IRS wanted to know how someone lived so well while reporting only $20,000 a year income. The audit turned into a lengthy CID investigation. Two CID agents pored over six years of Roy’s financial records, business and personal. Eighteen months later, Roy was indicted for criminal tax evasion.

At the conclusion of the criminal tax investigation, the CID has two options—drop it forever or recommend that the Justice Department prosecute. The IRS, a part of the Treasury Department, cannot directly prosecute anyone. If the investigation is terminated without prosecution, it doesn’t mean you’ve gotten off completely. Your case will be sent to an auditor, who can impose civil fraud penalties.

You will be pleased to know that in the great majority of investigations, the CID does not recommend prosecution. The Justice Department will prosecute only a select few cases. Therefore, the CID won’t waste its time referring (and in some cases even seriously investigating) a case unless it feels it has a sure winner.

If the CID does recommend prosecuting and the Justice Department gets a conviction, you can be imprisoned, put on probation, fined, or all three. For example, if you’re convicted of failing to file a tax return for three separate years, you can be sent to prison for one year and fined up to $25,000 for each year you didn’t file. The total could be three years in prison and $75,000 in fines. You will also have a permanent criminal record.

That’s not all. After a criminal conviction, an auditor will slap civil fraud and other penalties for underpayment of taxes. Combining criminal and civil punishment does not constitute double jeopardy—a constitutional guarantee against being tried, convicted, or sentenced more than once for the same crime.

If you are prosecuted but not convicted, you will nonetheless probably be audited.