No one likes to pay taxes. It's a universal truth. Nonetheless, millions of us pay our taxes and do it properly; we have income and we know that it has to be taxed, we file our returns on time (or get an extension, if needed), and we take only the deductions and credits that we're entitled to take. Not all taxpayers are alike, however.
Some taxpayers don't file tax returns at all, even though they should, because they think that federal income taxes are illegal. Some taxpayers take improper deductions, and some even try to hide money in other countries to avoid being taxed. Not all of these taxpayers purposely take part in such tax schemes, but some certainly do.
Unfortunately, some of us are tricked into believing that the tax schemes are legal ways to reduce our income taxes. This can lead to the IRS charging you hefty fines and penalties. Sometimes criminal charges can be filed against you, which carry even bigger fines and maybe even jail time. Clearly, paying your taxes is important, so you should know about some of the tax avoidance schemes and how to steer clear of them.
The most common crime charged by the IRS is tax evasion. This involves a willful, or voluntary and knowing attempt to avoid being taxed or paying a tax. To be convicted, you have to:
- Have a tax deficiency, that is, you owe taxes
- Make an "affirmative" act to evade or avoid the tax or paying it, such as filing a false return, which might include taking more deductions than you were entitled to
- Act willfully, for example, filing a tax return knowing that you should have reported more income than you actually reported
The penalties for tax evasion are steep: A fine of up to $100,000 and up to five years in prison.
Other crimes that you could be charged with include:
- Conspiracy, which is when you and at least one other person, such as your tax preparer or your spouse, agree to defraud the IRS by doing something like not reporting income or claiming too many deductions. Again, the penalties can be a fine and imprisonment
- False claims, which can come about if you file a false return or make false statements to an IRS agent during an audit when trying to explain why you didn't report all of your income, for instance
Specific Tax Avoidance Schemes
The IRS is aware of and actively investigates numerous tax avoidance schemes, also called tax scams. Some they have come across include:
Anti-Tax Law Schemes
These schemes are based on various arguments that the tax laws aren't valid and that you don't have to follow them or pay taxes. The arguments include things like the tax laws are unconstitutional because the 16th Amendment, which establishes income taxes, is invalid, and that the IRS can assess taxes only against citizens who actually file tax returns. There are numerous arguments, but the fact of the matter is that they've all been rejected by the courts. The federal government can lawfully tax your income, and you have the legal duty to pay it. So, if you meet someone who tells you otherwise, it's best that you ignore him and pay your taxes.
Some taxpayers buy into scams in which they're led to believe that they can escape income taxes if they put their money into bank accounts or businesses in foreign countries. These countries, known as "tax havens," typically have very lenient tax laws and strict rules about disclosing your financial and banking information to others, including the IRS.
There are legitimate, legal reasons for you to have money or assets in a foreign country, such as when you have a company that actually does business in that country. However, if your only goal is to hide or conceal money to avoid US income taxes, you should know that it's still subject to US income taxes. Usually, the only persons who benefit from these offshore arrangements are those who talked you into the scheme - the "promoters" - who gain by charging you fees for setting up and managing the scheme.
Tax shelters are a way for you to legally lower your taxable income, which in turn lowers the amount of taxes you'll owe at the end of the year. There are all kinds of legitimate tax shelters, but one you're probably familiar with is your 401(k) retirement plan that your employer has set up. You put money in the 401(k) throughout the year, and that money is not included in your taxable income.
There are, however, dozens of tax shelters that are illegitimate and are set up to either hide your income or assets or to generate or create false losses on your "investment" that you can use to offset your taxable income. The IRS maintains a list of abusive tax shelters that you should look at before you decide to use a tax shelter.
When it comes to taxes, the old adage applies: If it sounds too good to be true, it probably is. If someone offers you a "plan" to save on your taxes, it's wise to be a bit skeptical. Carefully research the plan, or get some advice from an experienced tax lawyer.
Questions for Your Attorney
- I honestly believed that I didn't need to pay any income taxes, but now I know better. Can I voluntarily pay my back taxes without having to pay fines, penalties, and interest?
- I think my accountant is giving me bad advice on my deductions; she wants me to take deductions that I don't think I should take. What should I do? If I say something to the IRS, won't they audit me for the last 5 years?
- What should I look for in a good, reputable tax shelter?