The majority of taxpayers and tax preparers file honest returns and abide by the rules. But beware: There are those who would encourage you to skirt the rules in order to give your tax refund a boost. With the onset of tax season, the IRS is eager to remind taxpayers of some of the most important rules we need to follow. To that end, it has recently completed its annual list of tax-system abuses that can get taxpayers in serious trouble.
Here are seven tax moves you should never attempt -- no matter how much money they might save you in the short term.
1. Trying to pad your refund
Beware any tax preparer who promises big savings and huge refunds based on credits, deductions, or rebates you have never been able to claim before. They may also encourage you to claim zero earnings on your return or claim deductions you are not entitled to, with the promise of a larger refund. You may have heard about other taxpayers getting away with these things, and you may even be tempted to do them yourself to obtain a bigger refund. Don't fall for it -- this is illegal and can lead to fines, imprisonment, or both.
2. Claiming excessive business credits
Some taxpayers like to claim credits they're not entitled to in order to inflate their refund. Examples include the fuel tax credit, which is limited to farm equipment or off-highway vehicles, and the research credit, which is designed to encourage businesses to invest in research and development. Unscrupulous preparers can recommend these strategies, or taxpayers may use them to try to increase their refund. The IRS prosecutes those involved in these dishonest schemes, and if you're convicted, you may pay a penalty of $5,000, in addition to any tax you would have owed. Just say no.
Now here's one thing you should do when claiming legitimate business credits: Keep thorough records of all the expenses you intend to claim. That way, if the IRS suspects you got greedy and claimed credits you didn't earn, then you'll be able to prove they were legit.
3. Falsely inflating deductions
The IRS wants taxpayers to "avoid the temptation to falsely inflate deductions or expenses on tax returns." Most taxpayers are honest and file an accurate return. Others may want to exaggerate the amount they've given to charity, as an example. You may think, "everybody does it, so it's no big deal," but cheating on your return can result in fines, penalties, and criminal prosecution. It just isn't worth it.
4. Fraudulently claiming tax credits
Some preparers will advise taxpayers to falsely inflate income in order to claim or maximize refundable credits they wouldn't be entitled to, such as the Earned Income or Child Tax Credits. This could involve the use of a phony 1099 or fictitious self-employment income. Beware: Any false statements or omissions on your tax return are illegal, and if a preparer suggests something like this, find a new one.
5. Abusing tax shelters
Some wealth planners, accountants, or promoters will attempt to persuade business owners to engage in the use of "tax shelters" to avoid paying their fair share of taxes. This complex scheme's only real purpose is tax evasion, which is illegal. These involve dodgy insurance scams using a little-known business practice called "captive insurance." This method of self-insurance, which is owned by those it insures, is legal, but only in extremely limited circumstances. Taxpayers must meet very specific criteria, and most are ineligible.
If someone suggests using this arrangement to avoid paying taxes, get a second opinion. IRS Commissioner John Koskinen stated: "Taxpayers should avoid unscrupulous promoters who encourage the use of phony tax shelters designed to avoid paying what is owed. These scams can end up costing taxpayers more in penalties, back taxes and interest than they saved in the first place."
6. Trying to shirk your duty as a taxpayer
There have always been those who claim that paying income tax is unconstitutional or that the IRS doesn't have the authority to collect them -- and they have always lost in court and in fights with the IRS. Some scammers claim that only federal employees are subject to tax, that only foreign earned income is taxable, or that the tax courts don't have authority over them. Don't be persuaded by anyone claiming that these are legal loopholes. Pick up your things and head for the door.
7. Hiding money in offshore accounts
Hiding money in an offshore account may sound like something out of a cheesy made-for-TV-movie, but it actually happens, and not just among the rich and famous. Beginning in 2009, the IRS has provided several opportunities for taxpayers to voluntarily disclose these holdings and resolve their tax obligation without fear of criminal prosecution. Since then, more than 100,000 taxpayers have made these disclosures, allowing the IRS to collect $10 billion of the tax revenue it was owed. The IRS works with foreign banks and governments to discover undisclosed accounts, and this reporting is increasing.
This is a fairly comprehensive list of best practices taxpayers can use to avoid running afoul of the IRS. Fraudsters and unethical preparers may recommend any of these methods to avoid paying taxes. Educating yourself and staying skeptical will go a long way. If it sounds too good to be true, it probably is!