IRS Collections

Are frequent flier miles or credit card points considered income by the IRS?

As a serial credit card churner, I am particularly interested in the IRS’s view on this matter, which is why I awaited with bated breath the United States Tax Court decision on the case between Parimal H. Shankar and the Commissioner of the Internal Revenue, back in August of 2014.

The issue in this case was whether Mr. Shankar had or hadn’t understated his income by $563 when he failed to report the Citibank points he used toward a trip. Mr. Shankar opened an account with Citibank and received some Citibank “Thank Your Points” as a reward. He then used those points toward the cost of a trip. The IRS argued that Mr. Shankar should have reported the savings from the ticket, the $563, as income.

The U.S. Tax Court decided in favor of the IRS. So does this mean all frequent flyer points should be declared as income? Thankfully no, the Tax Court was very careful about how it worded its decision and made it clear the decision was to have only a narrow application. The IRS sometimes considers frequent flyer miles and reward points as income, but not always. (U.S. Tax Court)

Welcome to the shady world of frequent flyer miles and credit card reward points. Hang in with me. We will get some clear answers by the end of the article.

So how does the IRS consider frequent flier miles or credit card points?

That is a good question. Are frequent fliers a prize, interest, a rebate or all of the above? The answer to that question largely determines whether they are a source of income and therefore taxable.

What has the IRS said on this subject in the past?

Nothing definitive or we wouldn’t be having this conversation, but a 2002 private letter ruling does provide insight on the IRS’s view on miles and points. The key section for our purposes says:

“ … the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.”

When I read that I gave a small sigh of relief. It didn’t last long. The next paragraph had this to say:

“This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes.”

Another tidbit from the IRS’s collective psyche was revealed in IRS Publication 17 Other Income, which says under the section of Rewards:

“Rewards. If you receive a reward for providing information, include it in your income.”

Before the IRS vs Mr. Shankar case, the last time the taxation of frequent flyer points hit the media was in 2012, when it was reported that Citi had issued 1099-MISC tax forms to clients who had received reward miles for signing up for a new checking or saving account. At least two clients sued Citibank for not disclosing that information when they advertised the extra points. (LA Times)

So are miles or points taxable or not? 

The IRS is playing a wait-and-see game on this issue, so it’s impossible to be dogmatic. However, this much we can say from a careful analyzes of previous decisions, comments and rulings.

The Bottom Line: Rebate vs Interest

As indicated by the Tax Court decision on Mr. Shankar’s case, mentioned above, if you received the points or miles as a bonus for opening a bank account and making a deposit, the IRS could consider it as income.

This is because you are receiving the rewards in exchange for what amounts to “lending” money to the bank, which is interest and therefore a taxable source of income. Also, you didn’t buy anything to qualify for the bonus, so it can’t be considered a rebate.

To illustrate, last month Chase bank offered me $200 for opening an account and leaving my money with them for 6 months. There were no other strings attached so I was happy to transfer my emergency fund to another bank for $200. However, I know I’m going to have to declare the $200 as income.

The same would apply if I received 50,000 points or miles for opening an account. The only problem with points is that their cash value is not always easy to calculate. A ballpark ratio that often works is one cent per mile/reward point, but a lot depends on the rewards program and how you decide to spend your points.

Now the good news.

The IRS considers points you receive from using a credit card as a rebate. Sure, it may feel like free money when you get a signup bonus of $500 to spend on travel expenses, but you probably had to spend $2,000 to $3,000 in three months to receive the bonus. Technically, it’s a rebate.

As long as you had to make some kind of purchase or financial transaction to receive the points or miles, the IRS considers it as a price reduction not interest. This doesn’t mean things couldn’t change in the future, but right now, fellow credit card-churners, we are in the clear.

There is one caveat. The IRS will not allow you deduct a business expense you paid with frequent flyer miles or reward points. For instance, let’s stay you are the owner of a company and you declare the cost of plane tickets on a business trip but you pay for the tickets with points or frequent flyer miles. The IRS considers this as double dipping. If you use miles or points to pay for expenses and then declare the full cost as a deductible expense, you could get into trouble with the IRS.

Learn more about tax deductions for business travel in this article.

IRS Tax Audit Penalties: What You Should Know

If you have been summoned for an audit by the IRS, you should know that the odds of escaping without owing additional taxes are slim. In general, the IRS does not spend its resources on conducting tax audits unless there is a good chance for significant revenue to be gained.

What you may not be aware of is that, if you owe more, along with extra taxes, you will likely be assessed penalties of some type. The amount and severity of the tax audit penalties that you face are directly related to the type of deficiency the audit uncovered. But you also have the opportunity to soften the blow or perhaps even have the penalties removed.

Accuracy Related Tax Penalties

If an IRS audit finds that you filed a substantially inaccurate return, you could be facing accuracy related penalties of 20 percent of the amount you underpaid. In extreme cases, the penalty charged could be doubled to a whopping 40 percent of your total tax underpayment. The following list indicates the types of accuracy related penalties that may result from a tax audit. (About Money)

  • Negligence or Disregard of Regulations. Failure to make a reasonable attempt to adhere to Federal tax code rules, such as failing to file a tax return at all
  • Disregarding IRS Rules or Regulations. Positions taken on tax returns that are substantively inconsistent with IRS regulations
  • Substantially Understating Your Taxes. Understating your income by $5,000 or 10 percent, whichever is greater.
  • Substantially Misstating the Value of Property. Overvaluing of donated property or undervaluing of depreciating property by 200 percent carries a 20 percent penalty. Overvaluing donated property or undervaluing depreciating property by 400 percent carries a 40 percent penalty
  • Substantially Overstating Pension Liabilities. Overstatement of pension liabilities by at least 200 percent carries a 20 percent penalty; overstatement of pension liabilities by 400 percent carries a 40 percent penalty. No penalty will be applied if the overstatement is $1,000 or less
  • Substantially Understating a Gift or Estate. Erroneously stating the value of property claimed on a gift tax or estate tax return at 65 percent or less of its actual market value carries a 20 percent penalty. Erroneously stating the value of property claimed on a gift tax or estate tax return at 40 percent or less of its actual market value carries a 40 percent penalty. No penalty will result if the understatement results in a tax underpayment of $5,000 or less.
  • Understatements Related to Reportable Transactions. 20 percent penalty for understating tax liabilities due to a tax shelter or tax avoidance transaction that are disclosed. Inadequately disclosed tax shelters or tax avoidance shelters that carry a 30 percent penalty.

Penalties for Failure to File Returns and Pay Taxes

If you are late in filing your tax return or paying your taxes, the penalty is 5 percent of the unpaid tax, charged each month, up to a maximum of 25 percent. A minimum penalty of $135 can be charged for returns filed more than 60 days late. Filing your return on time but paying late carries a lighter penalty of 0.5 percent of the tax you owe each month up to 25 percent. If you are charged for both penalties for the same month, the penalty for failure to file is reduced to 4.5 percent. (IRS.gov)

If you fail to pay up on taxes owed after an audit, the IRS will assess a penalty of 0.5 percent for each month the tax is not paid. The clock starts ticking 21 days after the IRS issues the notice. If you pay the amount owed in full within 21 days, you will not be charged an additional penalty.

To add insult to injury, if an audit results in accuracy related penalties, fraudulent failure to file a tax return or civil fraud, the IRS adds interest of 3 percent annually to the amount of your penalty. If the penalty is $100,000 or less, you have 21 days to pay in full before interest is added. If the penalty is more than $100,000, you only have 10 days to pay up before the IRS begins adding interest.

Civil Fraud Penalty

If an IRS audit results in a charge of civil fraud, you won’t wind up in jail. But the IRS slaps a hefty 75 percent penalty on any tax underpayment that resulted from fraudulent activity.

There is one sliver of a silver lining to this financially dark cloud — accuracy related penalties cannot be applied to taxes owed as a result of civil fraud. In other words, you can’t be penalized on top of a penalty.

Fraudulent Failure to File a Tax Return

If you mistakenly believe that you were not obliged to file a tax return and the IRS catches up with you through an audit, you’ll be hit with penalties for failure to file and failure to pay, but you won’t be charged with fraudulent failure to file a tax return.

Instead, fraudulent failure to file a tax return refers to a deliberate failure to file a return, and can be either a civil or misdemeanor criminal offense, although civil charges are much more common. If criminal charges are filed, you could be sentenced to up to a year in jail plus $25,000 in fines for each year that you fail to file. The statute of limitations for criminal charges is six years; there is no statute of limitation for civil charges.

Willful Failure to Pay Estimated Taxes or Keep Records

Willful failure to pay estimated taxes or maintain tax records is considered to be a misdemeanor by the IRS. Just as with fraudulent failure to file a tax return, civil rather than criminal penalties are applied most often for this type of infraction. If the IRS brings criminal charges against you, as the result of an audit or criminal investigation, you could face up to a year in jail and $25,000 in fines for each year for which you are charged.

Filing a Fraudulent Return

Many tax protesters, including actor Wesley Snipes and singer Lauryn Hill, have found themselves on the wrong side of the law because they filed frivolous returns based on claims that income taxes are unconstitutional. Filing a fraudulent tax return is considered a felony, but less serious than tax evasion. If you are convicted of filing a fraudulent return as a result of an audit or as a result of IRS investigation, you could face up to 3 years in prison and up to $100,000 in fines. (IRS.gov)

Tax Evasion

Tax evasion has snared some of the most notorious figures in history, including Chicago crime syndicate boss Al Capone. The IRS defines tax evasion as the willful concealment or misrepresentation of financial resources and assets to avoid paying taxes. If an IRS audit or criminal investigation results in a tax evasion conviction, you could be facing up to 5 years in prison and up to $100,000 in fines.

Audit Reconsideration

If worse comes to worse and you are nailed with more taxes and penalties as the result of an audit, but you disagree with the result, you can request an audit reconsideration. You must request it before you pay any taxes, penalties or interest that you intend to dispute, not after. If you have already paid the taxes, penalty and interest, you must request a refund. Submit the following documentation to the same office that conducted your audit. (Journal of Accountancy)

  • Statement explaining your reasons for requesting an audit reconsideration
  • Form 1099, cancelled checks, bank statements and similar new documentation
  • Copies of previously supplied materials
  • Copies of correspondence from the IRS

The IRS is not obligated to grant your request. But if you can demonstrate any of the following circumstances, your request for audit reconsideration should be approved.

  • You did not appear for the audit
  • You moved and did not receive proper notice for the audit
  • You submitted documentation that the IRS refused to consider that would reduce or eliminate the taxes, penalties or interest you owe
  • You have new documentation to support your case
  • You file a return that shows the correct tax to replace a return created by the IRS because you previously failed to file a return
  • The IRS committed math or processing errors in calculating the tax you owe

The IRS should respond to your request for an audit reconsideration within 30 days, although the wait could be longer. Bear in mind that penalties and interest continue to accumulate during that time. If you are suffering financial hardship due to delays in processing your audit return, you can ask for your request to be expedited.

Offer in Compromise and Penalty Abatement

If your request for audit reconsideration is denied, you may still be able to ease your burden. If you cannot pay the full amount of tax that you owe, you may request an Offer in Compromise, which settles your tax obligation for a fraction of what you actually owe. Be forewarned that the IRS accepts only a small percentage of Offers in Compromise. Obtaining expert advice from the experts at Optima Tax Relief will improve your odds.

Under certain circumstances you may request a penalty abatement, which results in some or all the penalties you have been charged being waived. The IRS generally approves requests for penalty abatement based on reasonable cause or administrative waivers. To request a penalty abatement, file IRS Form 843 along with copies of any documentation you may have to support your request.

Tax Tips: When does the IRS file criminal charges?

Statistically, your chances of being charged with criminal tax fraud or evasion by the IRS are minimal. The IRS initiates criminal investigations against fewer than 2 percent of all American taxpayers. Of that number, only about 20 percent face criminal tax charges or fines.

Related Article: The IRS Criminal Investigation Process

Unofficially, the minimum amount of unpaid taxes required to trigger an IRS criminal investigation is $70,000. And since the majority of Americans don’t even earn that much money, it’s easy to see why ordinary taxpayers need never worry about facing tax evasion or fraud charges.

While honest mistakes or even negligence generally won’t trigger a tax investigation, perpetrating fraud very well might. IRS agents are trained to recognize signs of criminal tax fraud and evasion. Exhibiting behaviors the IRS calls “affirmative acts” could eventually result in that fateful knock on the door from the IRS.

Negligence versus Tax Fraud

Back in the day, it seemed like the IRS was lying in wait, prepared to strike unsuspecting taxpayers at the slightest sign of tax error. These days the IRS is more tolerant of mistakes made by honest taxpayers.

When the circumstances are not clear cut, the IRS frequently errs on the side of giving the taxpayer the benefit of the doubt. Miscalculating the amount of your Earned Income Tax Credit is a mistake that could cost you a significant sum of money, but it isn’t usually considered to be tax fraud. Artificially concealing $800,000 of income by keeping two sets of books? Tax fraud. (Nolo)

Evidence of Fraud

Four so-called elements of fraud are recognized by the IRS: deception, misrepresenting material facts, submitting false or deliberately altered documents and failing to submit critical documents, such as tax returns. Several elements of fraud must occur together to trigger IRS fraud charges. But a single element that occurs in an especially blatant fashion may generate IRS tax fraud charges.

For instance, failure to submit a tax return for a single year is not usually considered to be an element of tax fraud. On the other hand, unless your income is extremely low, failing to file any tax returns ever could very well cause the IRS to initiate a criminal investigation against you.

Badges of Fraud

The list below, taken from the IRS.gov website, represents several “badges of fraud” the IRS looks for when determining whether to file criminal charges.

Badges of fraud fall into four general categories: improper reporting of income, unjustified deductions or tax credits, inadequate record keeping and outright illegal behavior. As with elements of fraud, IRS agents are inclined to give taxpayers the benefit of the doubt. They’ll impose penalties for taxpayers in arrears rather than bringing criminal charges against them.

  • Understatement or omission of substantial sums of money
  • Fictitious deductions
  • Maintaining “shadow” sets of accounting records
  • Deliberate destruction of records
  • Evidence of consistent underreporting of income
  • Obviously nonsensical explanations for behavior
  • Refusing to cooperate with an auditor or examiner·
  • Deliberately concealing assets, as in overseas tax shelters
  • Illegal activities
  • Dealing exclusively in cash
  • Maintaining obviously inadequate records
  • Indicators of Fraud

The IRS categorizes indicators of fraud into six broad categories: income, expenses and deductions, books and records, income allocation, methods of concealment and taxpayer conduct.

Just as with elements of fraud and badges of fraud, the difference between negligence and criminal conduct is often a matter of extent. Indicators of fraud usually include an element of deliberate conduct as well. An extensive list of actions that constitute indicators of fraud are available on the IRS website, but the examples below should provide a general idea of how the IRS views indicators of fraud.

Example #1:

Forgetting to include income from a W-2 form is not considered an indicator of income fraud. Insisting on being paid cash wages for a job and refusing to list any income from that job on your federal income tax return would be considered to be an indicator of income fraud.

Example #2:

Miscalculating the percentage of business versus personal use for your computer is not considered an indicator of fraud for expenses and deductions. Attempting to deduct the entire cost of your vacation to the Bahamas because you answered a single work-related email from your hotel room WOULD be.

Don’t Be Evasive

In general, if you suspect that a particular type of conduct is disallowed by the IRS, you shouldn’t do it. If you go ahead and do it anyway, you run the risk of being cited for tax evasion or tax fraud. And if you do receive that dreaded knock on the door from the IRS, you should not be surprised.

Additional Tax Tips:What to do during an IRS Audit
How to survive an IRS tax audit

Dealing with an IRS Audit – 10 Expert Tips

You have received the dreaded notice that your tax return is being subjected to official review. In other words, you’re being audited. While an audit is never good news, neither is it necessarily a catastrophe. Keep your wits about you and follow a few strategies suggested by experts, and you will survive your audit and live to file another tax return.

1. Know What Type of Audit You Are Facing

There are three types of audits: correspondence or mail audits, office examination audits and field audits. An overwhelming percentage of all audits – approximately 75 to 80 percent – are correspondence audits. Correspondence audits are usually limited to one or two specific questions. Once the IRS receives satisfactory responses, you’re done.

Office examination audits are conducted at a local branch of the IRS. You will need to attend in person, but you are allowed to be accompanied by your accountant or attorney. Field audits are conducted on your turf and are the most comprehensive. As with office examination audits, you are allowed to have representation present during a field audit. In fact, it is highly advisable.

2. Understand What Auditors are Seeking

While each audit is different, all audits focus on three basic questions:

  1. Is your business truly a business – or just a hobby?
  2. Are your deductions legitimate?
  3. Did you report all your income?

If you can answer these three questions to the satisfaction of the auditor, you stand a good chance of emerging from an audit relatively unscathed.

3. Get Your Ducks in a Row Beforehand

Read the letter you receive carefully. If you are dealing with a correspondence audit, determine which documents you need to collect to respond to the questions posted in the audit notification letter. If you must report in person for an office audit or prepare your home or office for a field audit, ensure that your paperwork – and your representative – will be available and ready. Prepare your responses to the points that have been raised for the years that have been included in the audit notification letter.

4. Ask for More Time if Needed

In most cases, you should have sufficient time to adequately prepare for an audit. But if you must retrieve past year returns or other documents that are difficult to obtain, you may need more time.

Ask for a recess or an extension as soon as you know you will need one. If the IRS refuses, mention that you want more time to obtain professional advice – a request which the IRS must grant.

5. Be Totally Truthful in Your Responses

Seriously, lying to an IRS auditor is a bad idea. First, IRS auditors will frequently ask questions to which they already know the answers, just to determine if you are being straight with them. Get caught in that sort of a lie and you’re done. Second, IRS auditors are not likely to take your word for whatever you say. If you make a false claim, you will have to provide false documentation to back it up. Can you see how this sort of conduct could eventually lead to a criminal tax fraud or tax evasion charge? Just don’t do it.

6. Don’t Volunteer Information

Be as transparent as possible in your responses to the questions you are asked. At the same time, do not volunteer information that the IRS agent has not requested. If your audit only covers two years worth of taxes, don’t offer paperwork for the last decade’s worth of expenses. If you want to prepare documentation for the past decade just in case, that’s fine, but let the IRS agent do his or her own job.

7. Substantial Compliance Is Your Friend

Nobody is perfect. Even the IRS recognizes this. If you can prove that you have properly claimed a tax deduction or credit, odds are good that the IRS agent will allow it, even if you lack some documentation. The IRS calls this substantial compliance. This doesn’t mean that you can be sloppy about documentation. It does mean that if you just can’t find one drink receipt from a business trip but your hotel bill, airfare receipts, meeting agenda and other documentation are in order, you can probably relax.

8. If You Disagree, Appeal

If you disagree with the outcome of an IRS audit, you do have the right to appeal. Begin by contacting the auditor directly. If you can’t get satisfaction that way, go to his or her superior. If you’re still not satisfied, more formal recourse is available.

One option is to request alternative dispute resolution (ADR). You may also file a request with the Office of Appeals. You may also file legal action with the Tax Court. If you are slapped with tax penalties in addition to owed taxes, you may be able to get at least some of them waived, reduced or abated — eliminated altogether. (IRS.gov)

9. If You Agree but Can’t Pay, Negotiate

If you agree with the outcome of the audit, even grudgingly, but you just don’t have the cash to pay what you owe in full, don’t panic. Pay what you can and negotiate for terms you can deal with to cover the rest. If you owe $25,000 or less, you may request an installment agreement by filing Form 9465, Installment Agreement Request either online, by mail or in person. If you owe more than $25,000, file Form 9465-FS, Installment Agreement Request. You may also make payments by automatic payroll deduction by filing Form 2159, Payroll Deduction Agreement.

Related article: Top 10 Benefits of Working with a Professional Tax Relief Firm

10. Don’t Go it Alone

With the very simplest of correspondence audits, you may be able to gather the necessary paperwork and respond on your own. Nonetheless, it doesn’t hurt to have an accountant or a tax professional like those at Optima Tax Relief check over your response before you send it to the IRS. For in-person audits, hiring a professional to help you deal with your audit is highly advised. If you aren’t sure, find out if you need to “lawyer up” here.

How to Know if the IRS Is Auditing You

You may be under the impression that if you’re being audited, you’ll find out by a strong knock at your front door. Unless you’re in serious trouble, this won’t be the case.

How will you know if you’re being audited?
Short Answer: The IRS will let you know directly.

The only way you’ll know for certain if the IRS is auditing you is if the IRS tells you – either by phone or mail. If your initial contact is by email, it’s likely a scam and you should report it.

Who is most likely to be audited?
According to Bloomberg News, only 1% of all tax returns each year are audited. But there are factors that increase your chances of being targeted for an IRS audit.

  • Being rich. 12.5% of all tax returns for those who make over a million dollars a year.
  • Mistakes on your tax return. This could be anything from not reporting all of your income, your numbers not matching with your employer-provided W2s, or even math errors on your tax return. Don’t round your numbers.
  • Self-employed. The IRS will look at your deductions to see if they are the typical amount for someone in your industry. Travel/entertainment and automobile deductions are watched especially closely. While a home office is no longer an immediate reason to suspect an audit, taking the deduction needs to be backed up with detailed records.
  • Large charitable donations. If you only make $20,000 a year and yet donated a substantial amount of money, watch out.
  • Your associates. If your business partner in a firm or a close relative is being audited, you could be too.

Types of IRS Audits
There are three types of IRS audits, depending on the complexity of your return, the number of questions the IRS has and the dollar amount involved.

  • Correspondence Audit – An IRS tax audit conducted entirely by mail. The IRS likely has a short checklist of questions to ask you about your income, expenses, or itemized deductions.
  • Field Audit – The IRS will send an agent to visit you in person in your home or business. They will want to inspect the records you’ve kept.
  • Office Audit – You are requested to meet with an agent at their nearest office and bring your paperwork with you to the meeting.

If you are audited there are four things to remember:

  • Respond to their letters within the deadline given on the notice. If you need more time, you’re far more likely to get an extension if you ask for it before the deadline’s passed.
  • Gather all the documentation you need to answer their questions and provide copies to the IRS. (Never give them your original documents, they aren’t responsible if anything is lost.)
  • Bring the right representation. Not your Uncle Bill but a CPA or tax attorney. This is not the time for amateur help or to go it alone.
  • Be polite and respectful. But don’t volunteer anything. If the agent wants to expand the audit, you are entitled to more time to answer any new questions that may arise.

An IRS tax audit can be a painful experience but you will get through it with thorough preparation, and if needed, expert help from Optima Tax Relief.

Additional Tax Tips:

The IRS Criminal Investigation Process
What to do during an IRS Audit
What does the IRS look for in an audit?
IRS penalty and interest rates

What Is The IRS Criminal Investigation Process?

Most of the woes associated with the IRS involve money. If you are audited, the most probable outcome is that you will owe more money to the IRS. In the worst case scenarios, an audit results in your owing a lot more money. But you almost never face criminal charges.

An IRS criminal investigation is an entirely different ball of wax. The IRS pursues about 3,000 prosecutions each year for tax fraud and tax evasion. If the IRS launches a criminal investigation against you, you not only face a potentially substantial tax bill, but also possible jail time. One of your first moves should be to obtain the services of a skilled, experienced attorney who specializes in tax law.

The Knock at the Door

Your first encounter with the criminal investigation unit of the IRS may involve a knock on your door, followed by an intimidating encounter with two or more agents dressed much like K and J from the Men in Black movies. By the time this encounter takes place, the IRS has completed several steps of its investigation process and is convinced that the case against you is solid. Your best move under these circumstances is to say absolutely nothing.

Areas of Potential Criminal Prosecution

The IRS website lists the following areas of possible criminal prosecution. Some areas of criminal prosecution such as abusive tax schemes and nonfiler enforcement are more likely to apply to individuals. Others, such as money laundering and employment tax evasion, are more likely to be committed by corporations and criminal operations.

  • Abusive Return Preparers
  • Abusive Tax Schemes
  • Bankruptcy Fraud
  • Corporate Fraud
  • Employment Tax Evasion
  • Financial Institution Fraud
  • Gaming Related Fraud
  • General Tax Fraud
  • Healthcare Fraud
  • Insurance Fraud
  • Money Laundering
  • Mortgage and Real Estate Fraud
  • Narcotics Related Financial Fraud
  • Nonfiler Enforcement
  • Public Corruption
  • Questionable Tax Refunds

How Criminal Investigations Are Initiated

Those stories you read about neighbors ratting each other out to the IRS? That actually does happen. The IRS is happy to accept tips about possible tax fraud or tax evasion from family members and associates. A revenue agent or revenue collection officer may also initiate a criminal tax investigation if something about your return seems fishy. A U.S. Attorney or even your local law enforcement department may also provide tips to the IRS about possible fraudulent or criminal tax activity. Social media is also another resource.

Primary Investigation

Of course, the IRS isn’t supposed to go off half-cocked based on an accusation made by someone with a long-standing grudge. Instead, any tips or information is subject to what the IRS calls a primary investigation. The agent makes an initial judgment on whether to proceed with further investigation. If the decision is in favor of pursing criminal charges, the tax agent’s supervisor has the opportunity to sign off on the investigation or stop it in its tracks. If the supervisor gives the go-ahead, then the case is brought to the special agent in charge – the head of the office.  That person makes the determination of whether to go ahead with a “subject criminal investigation” based on one or more of the categories listed above.

Criminal Investigation

Once the IRS has obtained the go-ahead, the actual criminal investigation proceeds much like you think it would. The IRS gathers documents and affidavits from third parties, including your family, friends and professional associates to support its case. Other forms of investigation include search warrants, subpoenas of bank records and other financial data and covert surveillance.

Recommendations for Prosecution

After the investigation phase of the process is complete, the IRS special agent and his or her supervisor review the evidence that has been gathered. A determination is made whether to “discontinue” the case or proceed with prosecution. If the decision is made to prosecute, the special agent prepares a report which is reviewed by each of the following four IRS officers, in order:

  1. The supervisory special agent, aka the front line supervisor for the special agent
  2. Centralized Case Review – a criminal investigation review team
  3. The Criminal Investigation (CI) assistant special agent in charge
  4. The CI special agent in charge

If the CI special agent in charge gives the go-ahead to prosecute, the recommendation is forwarded to either of two final levels of review. Just as with any of the earlier stages of investigation, the IRS may decide that there is insufficient evidence to proceed with an actual prosecution. But once an investigation clears one of the two stages listed below, you are destined to receive that ominous knock on your door.

  1. The Department of Justice, Tax Division (for tax investigations)
  2. The United States Attorney (for all other criminal financial investigations)

Guilty or Not Guilty

You might have gathered by now that the IRS is meticulous about pursuing criminal cases against alleged tax cheats, and you would be right. But that does not mean that mistakes never happen or that actual prosecution is inevitable. You have the right to seek a conference with IRS agents at each stage of the process — if you are actually aware that the IRS is pursuing prosecution against you. You also have the right to request dismissal of the case either before or after a grand jury indictment, or to appeal a conviction.

If the IRS Has You in Its Sights

If you know that the IRS will find tax fraud or tax evasion, your best bet is to come clean. If you do so before a prosecution is underway, you can often avoid the criminal process altogether. The IRS allows taxpayers to make voluntary disclosures of unreported income or other tax obligations. The procedures vary according to whether your unlawful tax conduct involves domestic or international maneuvers. Your attorney can provide the best advice on whether – and how to make a voluntary disclosure. 

Additional Tax Topics:

IRS Penalty and Interest Rates
What to do during an IRS Audit

Donald Rumsfeld Thinks Taxes Are Complicated: Declares War

Former Secretary of Defense Donald Rumsfeld thinks that completing your federal income tax returns should be a lot simpler than it is. And you will never guess who agrees with him – liberal publication ProPublica, left-leaning policy wonk Ezra Klein, tax expert Austan Goolsbee and presidents Ronald Reagan and Barack Obama. What is it they say about strange bedfellows?

Taxes are Complicated

Rumsfeld voiced his frustration with the federal income tax code in a letter penned to the IRS with links to the letter posted on his Twitter feed. In the letter, Rumsfeld claimed that he and other Americans have “absolutely no idea whether our tax returns and our tax payments are accurate.” Rumsfeld also complained about the expense associated with completing his income tax returns each year.

Like 60 percent of the American public, Donald Rumsfeld does not complete his own federal income tax returns. Instead, he outsources the task of dealing with the IRS to a paid accountant. Ordinary folks with fewer financial means take a similar approach, except that their tax returns are frequently handled by firms like H&R Block or Jackson Hewitt. Many people who DO prepare their own tax returns do so with the guidance of software from TurboTax or TaxAct.

Taxes are complicated. According to the Tax Foundation, the most recent version of the federal tax code is a hefty 2,652 pages thick and includes more than 1 million words. The so-called “long form” 1040 lives up to its name, having swelled from 30 lines on a single page to 87 lines and more than 200 pages of instructions. The U.S. Tax code is so complex that the Tax Policy Center released a 100-page annotated version of Form 1040 which includes factoids for every line of the document.

The No-Return Tax Return Proposal

There is little doubt that an affluent taxpayer like Donald Rumsfeld has tax issues that require the services of a certified public accountant. But the truth is that most people in the United States have neither the income nor the circumstances to warrant the need to designate the task of completing an income tax return. This truth is the guiding principle behind a proposal to allow the IRS to complete tax returns itself, and send completed returns to taxpayers for their approval. Taxpayers who wished to make changes in the IRS-completed returns would be able to do so, but the requirement to file income tax returns would no longer exist.

The proposal, which Goolsbee and ProPublicacall the Simple Return, would supposedly save 225 million preparation hours and$2 billion in fees paid to tax preparers. According to a 2006 white paper written by Goolsbee and published by liberal think tank the Brookings Institution, adopting the Simple Return as a general federal tax filing policy would translate to the equivalent of $44 billion in tax savings for the American public over the next 10 years. The IRS would also save $36 million through a reduction of tax errors committed by taxpayers – and the need to conduct fewer audits. Several European countries, including Denmark and Spain have adopted variations of the Simple Return as standard operating procedure.

The plan has actually been tested in the United States. In 2004, the Franchise Board of California launched a pilot program called ReadyReturn, Approximately 50,000 single taxpayers with no dependents and income only from wages received pre-filled state income tax forms in the mail with the option to accept or decline the returns. More than 11,000 taxpayers accepted the ReadyReturns,equaling 27 percent of taxpayers who had not previously filed their California state tax returns.

Among taxpayers who declined the ReadyReturns, 22 percent stated that they had already filed their state income tax returns. Satisfaction among taxpayers selected for the ReadyReturn program was high: 90 percent stated that they saved time by filing their state returns through the ReadyReturn program. A hefty 98 percent claimed to be “satisfied”or “very satisfied” and 97 percent stated that they would use the ReadyReturnto file their state income taxes the following year.

The Astro turf Push back Campaign

Of course, the Simple Return proposal has not gone without a push back effort. Representatives from the Jewish community, the NAACP and mayors from small-town America have written op-eds and letters to the editor protesting against the Simple Tax proposal, according to ProPublica director of research Liz Day. The letters and op-eds, each containing similar language, claim that the Simple Tax proposal would potentially result in a higher tax burden for low-income Americans.

One possible reason for the similar language of the letters and op-eds may be that they were at least in part influenced by JCI Worldwide, a public relations and lobbying firm with connections to Intuit, which markets the tax software program TurboTax, according to ProPublica. In one instance, Rabbi Elliot Dorff,who wrote an op-ed in the Jewish Journal criticizing the Simple Return, stated that he was inspired to write the piece after being approached by a former student, Emily Pflaster, who sent him derogatory information about the plan. But Pflaster neglected to mention that she worked for JCI Worldwide in her appeal, the rabbi told ProPublica.

Ezra Klein, formerly of the Washington Post, posted an animated infogram on his recently launched website Vox explaining the principles behind Simple Return. According to Klein, another opponent of the Simple Return plan is anti-tax activist Grover Nordquist. According to Klein, Nordquist fears that if filing tax returns were easier, people would be less opposed to the IRS and the notion of paying taxes.

But Can We Really Trust the IRS?

There is no doubt that the tax preparation industry stands to lose millions if a policy like the Simple Return were put into action. And any connection to a tax-preparation software package is potentially damming to any protest efforts against the initiative. Nonetheless, there is merit to adopting at least some caution to adopting a plan like Simple Return.

Would taxpayers leave potential tax savings on the table by simply accepting pre-filled tax returns rather than making the effort to check them out for possible errors? In addition, the vast majority of Americans are entitled to file their federal income taxes electronically for no charge under the FreeFile program; many states allow taxpayers to file free tax returns as well. Nonetheless, with proper safeguards in place to ensure that taxpayers receive the maximum tax credits and deductions to which they are legitimately entitled, the Simple Return or something like it could be a welcome change from an increasingly labyrinth-like tax code.

Photo by Mark Wilson/Getty Images

The Top 500 Delinquent Taxpayers in California

When you’re more than $132 billion in the red, you have to get creative with your revenue. The California Tax Franchise Board certainly has. In 2007 it started compiling a list of individuals and corporations who owe at least $100,000 in California state taxes. The list started as a top-250 list but in April of 2012 expanded to 500.

The Top 500 Delinquent Taxpayers in California

Last year, the list received much more attention. Probably because it included celebrities such as actress and model Pamela Anderson, film director Nick Cassavetes, and Halsey Minor, the co-founder of CNET, who topped the list with nearly $11 million in back taxes.

This year the list lacks any big showbiz names. Instead it is dominated by lawyers, contractors, realtors, doctors and dentists, which isn’t going to sell many tabloids. As of December 2013, California’s top tax delinquents are Mon B. and Mimi Hom of Los Angeles, who owe a whopping $6.3 million in personal state income tax. The Corporation with the largest tax debt is Sharon A. Bogerty, M.D., Inc of San Jose, which owes nearly $3.4 million in corporate income taxes.

By law, the Franchise Tax Board is required to include the names and status of any professional licenses held by tax evaders on the list. In the case of corporations, the FTB must include the names and titles of the officers of the businesses on the list.

Additional Incentives

Naming and shaming is not the only method the Tax Franchise Board has to motivate delinquent taxpayers. New legislation passed last fall, the Delinquent Taxpayer Accountability Act, gives the Tax Franchise Board new powers, which give it the ability to inflict some serious pain.

These powers allow the Tax Franchise Board to suspend the occupational, professional and even driver’s licenses of delinquent taxpayers that make it on the list. This means you could lose your CPA license, medical license, or even your driver’s license if you don’t pay your taxes. Top 500 delinquent taxpayers are also banned from entering into contracts for providing services and goods to state agencies.

State Reciprocal Agreements

The Delinquent Taxpayer Accountability Act also grants the California Tax Franchise Board with the authority to enter into reciprocal agreements with its counterparts in other states. These agreements allow California to collect from taxpayers who live in other states by using their tax refunds in other states to offset the tax debts in California.

As of December 2013, the only state California has such an agreement with is New York. However there are plans to expand this to other states, such as Illinois. These “I’ll scratch your back if you scratch mine” deals allow states to target state income tax evaders who jump state after accruing large tax debts.

Naming and Shaming Works

Naming and shaming has reaped significant results. According to the Tax Franchise Board, more than $166 million have been recovered since 2007 through the Top 500 program. Further evidence of the program’s success is that celebrities who appeared in the 2012 list have since put their affairs in order with the taxman.

The Delinquent Taxpayer Accountability Act requires the California Tax Franchise Board to notify candidates they have 30 days to resolve their accounts to avoid appearing on the list. Many delinquent taxpayers provide the Tax Franchise Board with proof of hardship, set up an installment payment agreement or pay their debt in full, and their names are not published. This is why if you ever visit the TFB’s Top 500 list you won’t see 500 names.

If your name is on the list, Optima Tax Relief can help you make arrangements to resolve the issue or correct any mistakes. Contact us today at 1+800-965-3192.

Photo: BlueRobot

Boxer Fights Tax Wars on Two Shores

Manny Pacquiao battles BIR and IRS

Filipino boxing phenom Manny Pacquiao is hard to beat in the ring. Named the “fighter of the decade” in 2010 he’s a force to be reckoned with. Now, he can’t seem to catch a break. He’s in the ring with two formidable foes, the Bureau of Internal Revenue (BIR)in the Philippines as well as the IRS. The BIR says he owes 2.2 billion pesos (equivalent to $50.2 million) for income earned in 2008 and 2009.

Paquiao says that money was earned in bouts that occurred in the United States, and maintains he paid the taxes he owed on those amounts, to the IRS, as required. Thanks to a tax agreement between the two countries, taxpayers are not subject to double taxation, which is Pacquiao’s defense.

Tax commissioner Kim Henares, however, says that in two years, the boxer has provided no documentation, proving that he made U.S. payments. She told ABS-CBN television news, “2.2 billion (pesos) is what Pacquiao owes now because of surcharges and interest.” She added, even if he did pay the taxes due in the United States, he would owe more to the Philippines because their tax rate was higher at the time.

While he works to clear up the mess, his accounts in the Philippines have been frozen and a lien has been placed on his property worth millions, leaving him unable to pay his staff. If he does not pay the taxes owed, said Henares, the authorities could take the payments by stripping away his assets.

Now to the IRS

Pacquiao’s promoter, Bob Arum and his attorney, Tranquil Salvador maintain the U.S. taxes was paid and that proof is on the way. But in recent days, the IRS states he failed to pay income tax on his earnings from 11 fights in 2006 to 2010, leaving a tax debt of $18,313,668.79.

Pacquiao’s representatives say certified documents are on the way, which prove his U.S. tax liabilities were paid (at least for 2008 and 2009, the years in question by Filipino authorities). But they say they will not give the proof to the BIR, preferring to fight the charges in court.

To fight back against the tax authorities he went on a public campaign on all of the major TV networks in the Philippines, accusing the BIR of harassment. “I’m not a criminal or a thief. I am not hiding anything. I will face my problems as they come.”

Avoiding the U.S.?

As Pacquiao fights this battle on two fronts, the only thing that is clear is that he needs serious legal help to untangle the tax mess. Meanwhile, Arum has told reporters his client may never fight in the U.S. again because the tax burden is too heavy. Whatever he earns in the United States, 39.6 percent comes off the top. And depending on the state where the fight is held, another tax bite might be taken.

“Manny can go back to Las Vegas and make $25 million, but how much of it will he end up with — $15 million?” His client can fight in China for a smaller purse, $20 million, and keep all of it.” Arum added, “He’d have to be a lunatic” to fight in the United States and let his winnings disappear that way.

Tax matters can be complex even for those without foreign income issues. Toss in foreign tax agreements and the issues grow sticky pretty fast. Individuals with who have foreign income issues are advised to seek tax representation from professionals with vast experience untangling the tax web.

How to Obtain a Prior Year Tax Return

When you file your taxes, keeping a copy of the final return is highly recommended but sometimes not possible, or forgotten. Having that copy, though, is often required for many financial decisions. Reasons include answering questions related to an IRS audit or investigation, or on a student loan or mortgage application. If you cannot find or did not save a copy of a prior year tax return, we can help you.

Optima Tax Relief has compiled a guide to help you obtain your tax returns quickly and easily:

What Can I Request?

Upon request, taxpayers are able to obtain a tax return transcript and a tax account transcript.

Tax return transcripts contain most of the line items from your initial tax return along with line items from schedules and forms accompanying the initial filing. Changes made through amended returns, will not show up on this type of transcript.

Tax account transcripts document any modifications made by the filer or the IRS to the original tax return, including any adjustments and amendments. This document has information such as your return type, your adjusted gross income, taxable income and what your marital status is.

How Can I Request Transcripts?

Transcripts are free and can be requested via the web, over the phone or by mail. Using the IRS’s website, www.IRS.gov, requests are made using the “Order a Transcript” tool. Phone requests are made by calling (800) 908-9946 and following the prompts.

Individuals requesting a 1040A, 1040 or 1040EZ tax return transcript must fill out IRS Form 4506T-EZ, otherwise known as the Short Form Request for Individual Tax Return Transcript.

Individuals or businesses requesting a tax account transcript must complete IRS Form 4506T, also known as Request for Transcript of Tax Return.

How Far Back Can I Request Transcripts?

Transcripts are free, and available for the present year and each of the three years prior.

How Long Will It Take to Receive My Tax Return?

It normally takes 5-10 calendar days to receive your information if you request your tax information via online or over the phone. If you request your tax information by mail, it can take up to 30 calendar days.

What If I Need the Actual Copy of the Tax Return I Filed?

If you regularly use an online preparation software like TaxACT or TurboTax, retrieving old returns should be relatively easy. If not,  taxpayers can request and receive the actual paperwork they filed directly from the IRS. The current year’s paperwork and up to the past six years are available.

Individuals requesting this information must mail $57 per tax year and IRS Form 4506, Request for Copy of Tax Return. Turn-around time generally takes up to 60 calendar days.

What if I Live in a Federally Declared Disaster Area?

For taxpayers living in disaster areas, determined by the Executive Branch of the United States, the IRS may permit these individuals to request tax return paperwork. To see if you are eligible and your location qualifies, check out the IRS’ website www.IRS.gov and look for the “Disaster Relief” section. This section spells out all eligibility and application criteria.

It’s good practice to have prior year tax returns and other tax-related documents stored in a safe place and “in an orderly fashion” for a few years. You always want to be prepared in case of an audit!