Most people are aware that cheating on your taxes is against the law, but when it comes to tax compliance, not everyone is on the same wavelength about what constitutes “cheating” or the potential risks it poses. There is a difference between civil penalties and criminal penalties when it comes to IRS enforcement actions. Criminal penalties are rare—in the sense that most people avoid the behaviors leading to criminal tax activity. When one commits tax evasion or tax fraud, the IRS will likely seek criminal penalties. While criminal penalties seem rare, that may be partly because only a small number of cases are prosecuted by the IRS each year. However, before you think there’s nothing to worry about, you should know that in 2019 the IRS had a 91.2% conviction rate for the cases it did bring. The agency boasted about their success to send a message that they will continue to pursue aggressive enforcement strategies.
We certainly hope you are not intentionally cheating on your taxes! Even for the on-the-level, middle-of-the-road taxpayer, there are things that you may be doing (or not doing) that could put you at a higher risk of being audited and facing penalties.
Common Tax Compliance Issues
The most common way for people to dabble in tax “gray areas” is by under reporting income. While this may serve to lower your tax bill, at best it results in civil penalties and, at worst, could result in charges of tax evasion. At highest risk for under reporting are self-employed individuals or those working in a business that primarily uses cash transactions. Another risky behavior is writing off exaggerated or fabricated business expenses, which is also against the law.
For high-net-[GD1] worth individuals, tax compliance can be complicated significantly by the complexity of your tax affairs and the tax-planning mechanisms you are using to manage your wealth. While most high net worth individuals have one or more advisors—and most of them are likely great—you may be out of compliance by function of the multiple layers or strategies you have put in place. You may not even be aware that you are out of compliance, particularly if you are using the advice of multiple advisors who may not be cohesively viewing or planning with you.
The Risks of Tax Non-Compliance
If you are subjected to an audit and the revenue officer finds errors or omissions, three things could happen:
- Fines — These are commonly referred to as a civil penalty. Civil penalties are the simplest thing that arevenue officer can do topenalize you for non-compliance. These fees vary based on what the revenue officeruncovers. On the low end, 20% penalties could be added to your tax bill if the revenue officer suspects that it is the result of negligence; on the higher end, it could be 75% or more if they suspect it was fraud.
- Criminal Investigation— The revenue officer may also refer your case to the Criminal Investigation Division (CID) if they suspect you willfully committed tax fraud.
- Prosecution — IRS investigators can charge you with tax evasion or fraud, filing a false return or failure to file a return.
How to Avoid Tax Compliance Issues
The easiest way to avoid tax compliance issues is to have your taxes prepared by a licensed CPA and regularly reviewed by a knowledgeable tax attorney. These individuals can review your current financial situation and identify potential red flags. Then you can address those concerns early—long before an audit begins —so you can avoid the hassle and potential financial penalties.
Cantley Dietrich has a team of tax attorneys with a practice grounded in tax compliance for high-net-worth individuals. We work holistically with other advisors and strive for a cohesive, understandable, and compliant plan for your estate. Call us today to discuss how we can help you avoid the risks of IRS audits.