Taxes: 10 Ways to Cheat Like a Pro

Before bowing out as nominee for health czar, Thomas A. Daschle explained as best he could how he managed to overlook $340,000 of income on his 2005 through 2007 tax returns. His reason: The income (some cash and a lot of chauffeuring) didn't show up on his 1099s. These are the forms self-employed people such as influence peddlers receive instead of W-2 wage statements.

The former Senate majority leader seems to have something in common with his fellow citizens -- or at least those who contribute to the $345 billion annual gap (as of 2001) between what the Internal Revenue Service estimates taxpayers owe and what they voluntarily cough up.

Tax filers own up to nearly all the income the IRS can double-check against documents sent to it by employers, brokers and banks. But people are for some reason very neglectful when it comes to income and deductions that the IRS can't easily cross-check. They pay only 45 percent of the taxes owed in their noncheckable lives.

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"I run into it with clients all the time. The current system has built a mentality that if there is no W-2 or 1099, it's not reportable income," says Phoenix CPA Edward Zollars.

Daschle should have known better, but maybe it's understandable if ordinary folks think this way. Over the past two decades the number of 1099s and other information returns sent to the Internal Revenue Service has doubled -- to a projected 1.95 billion this year. IRS computers match most against individual returns and spit out 3 million-plus CP 2000 notices to taxpayers a year demanding an explanation for discrepancies.

Meanwhile, the ranks of IRS revenue agents (who perform the "field" audits that might find, say, unreported cash income) have shrunk 25 percent and the IRS has been busy battling dicey tax shelters, wacky tax protesters and hidden offshore accounts. The result: The IRS conducted field audits of only one in 440 taxpayers last year, half the rate in 1998. "The IRS doesn't have the resources now to do anything besides document matching for the bulk of the population," observes attorney Lawrence B. Gibbs, a Miller & Chevalier partner who was IRS commissioner in the late 1980s.

Yes, but don't get too cocky. As the table shows, the IRS is now using its shrunken field force to go after the better off. And it has ramped up use of a low-cost technique to attack deductions and credits claimed by ordinary folks: "correspondence," or by-mail, audits. Last year the IRS sent 1.1 million letters declaring deductions of some kind would be denied unless taxpayers mailed back acceptable documentation. "This paper tiger can make people's lives miserable," says Claudia Hill, a Cupertino, Calif. tax pro who edits CCH's Journal of Tax Practice & Procedure.

Here are some ways for the law-abiding (and the less so) to minimize IRS grief.

Study the charity rules. Congress has tightened rules on charitable deductions, making this a prime area for mail audits, says Hill. Gone are the days when Bill and Hillary Clinton could deduct $75 for giving a suit with ripped pants to the Salvation Army. You can't write off donations of small items in less than good condition and need receipts or canceled checks for any cash gift, even $10 put in the church collection plate.

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