The IRS recently reported that although 85 percent of Americans said cheating on taxes was unacceptable, 10 percent believed it was OK to cheat “a little here and there.” Three percent also said cheating “as much as possible” was acceptable.
“Once in a while we have a few [clients] who push the line, but nothing material and usually inadvertently,” said CPA Eric MacCollum of Hudak and Company in Wilmington, Del. Some rationalize doctoring numbers “by looking at themselves as being wronged or as victims not able to take advantage of loopholes they feel others use.
“We see this most when someone starts earning a higher income or has a big one-time event. They may think that high tax rates are a good thing until they feel the impact. We try to educate them on the burden high rates can cause and better educate them on how the system actually works,” MacCollum said.
Post-reform, the main area upsetting wealthy taxpayers is the $10,000 cap on state and local taxes, he added.
Cheating on tax returns commonly shows up in failure to report all income or gambling winnings; phony deductions and credits; number of dependents and legitimate tax credits; omitting received gifts; and paying others off the books. A recent Credit Karma tax survey also revealed that almost half of Americans believe super-rich men are the most likely to cheat on taxes and almost a third believe the wealthy were likely to cheat.
As the number of taxpayers and the taxes they owe continues to swell—14 million Americans owing some $131 billion in back taxes, according to some estimates—IRS investigators continue to be hamstrung by budget cuts.
“Tax compliance is essentially a gamble,” wrote John T. Manhire Jr., assistant dean in the office of entrepreneurship and economic development at Texas A&M in College Station, in his recent paper, “There Is No Spoon: Reconsidering The Tax Compliance Puzzle.”
“Taxpayers are motivated by the desire to maximize their expected utility given the punishment for cheating and the probability of getting caught,” Manhire wrote.
The biggest area where wealthy people tend to fudge a tax return is with the hobby-loss rules, according to Nick Preusch, a CPA and tax manager with PBMares in Fredericksburg, Va. “The most common examples are those buying a boat, airplane, race car or horse and then using the tax system to write off expenses,” he said.
“Post-tax reform, the biggest area where you could see [wealthy] individuals cheat would be with the IRC 199A deduction, 20 percent of business income,” Preusch added. “For higher-wealth individuals, the deduction will be based on W-2 expenses and their unadjusted basis in property. I can foresee businesses misclassifying independent contractors as W-2 employees to increase their deduction, assuming the math works on tax savings ... or faking assets on a fixed-asset schedule.”