It's probably no surprise that some taxpayers attempt to defraud the government (and the American public) by paying less taxes than they legally owe. When done on purpose, these are acts of tax evasion and fraud. However, it is possible to commit some of these acts unintentionally. The penalties are higher for fraud cases, however, they are not completely waived for the well-intended but perhaps uninformed taxpayer who makes an honest mistake.
There are two categories that almost all tax fraud examples fall into: Under reporting income and overstating deductions. Both of these occur frequently with self employed, sole proprietor businesses who report their income on Schedule C, which is why tax returns with Schedule C are audited at a higher rate than those without it.
Under reporting income If you work as an employee for a company and receive a W-2, it isn't really possible to under report that income. If you do, it's automatically adjusted by the IRS, a notice is sent, and you need to pay the taxes. This is because the W-2 is filed with the IRS and checked against your tax return. However, many individuals have other sources of income like running a "side hustle" or a small business. If you earn income by providing some sort of product or service to individuals, the IRS has no way to verify this income since individuals are not required to issue and file 1099s for payments made to a business. This knowledge entices some taxpayers to under report income thinking the IRS will never be the wiser. Many people actually believe that "cash income" isn't taxable income. However, this is completely untrue. No matter how you are paid, all income is taxable income unless specifically exempt in the tax code (such as personal gifts received). Some think that the money they make 'isn't enough' to report, or is a hobby not a business, or by having a net loss the income doesn't have to be reported. All of these are untrue as well. There are specific rules for hobbies vs. businesses (Have a side hustle? Is it a business or a hobby?), however, the income in all of these situations must be reported on your tax return.
Overstating deductions Another way to reduce your taxable income is by reporting deductions. This is why so many people overstate deductions by "rounding up" or simply fabricate tax deductions. It could be taking the tuition expense deduction when you didn't really qualify, overstating charitable contributions, reporting non-cash contributions that weren't really made, or reporting business expenses on a Schedule C that you didn't actually incur. Each of these is tax fraud and could cost you significantly in interest and penalties.
Falsely claiming tax credits This is very similar to # 2. Tax credits are similar to deductions, but offset your tax liability dollar for dollar instead of saving a % of taxes. The most common tax credit inappropriately claimed is the Earned Income Tax Credit. Other credits that are sometimes claimed even when the taxpayer doesn't qualify for them are the American Opportunity Tax Credit (for higher education expenses), the child and dependent care credit, or the retirement savers credit. There are many other credits, the point being, if you claim one you don't qualify for you are underpaying your taxes and could get hit with significant penalties and interest.
Whether these are done intentionally or unintentionally, you could be facing penalties and interest on unpaid taxes. If you hire a dishonest tax professional, it is possible they have fabricated deductions or under reported income in order to get you a larger refund. Since most taxpayers pay attention more to their refund than the actual taxes owed, some tax preparers will prepare fraudulent returns to make clients happy. As the taxpayer, you are still responsible for the taxes. The preparer could get hit with significant consequences, but it will not relieve you of your responsibilities for filing an accurate return and paying the proper amount of taxes.
-Brad
Read more about me. I enjoy helping individuals with their taxes, businesses (including nonprofits and churches) with tax or accounting and other finance related questions, and I also enjoy helping people resolve tax debt, liens, levies, or providing other tax help. I live in Lake Nona in Orlando, Florida, but I serve clients all across the country. Schedule an appointment if you need assistance and take a look at the resource page.
*The blog posts (as well as the YouTube channel) are my personal opinions and thoughts about a wide range of topics. They are not meant to apply to individuals specifically and should never be relied on as tax or investment advice. You should contact a professional for specific advice before taking action.