The
following question came up this year. It was from an experienced CPA, so I was surprised
that he even asked:
Are there rules on overstating income on a tax return?
You can
anticipate the thought process. It is intuitive why one is not allowed to
overstate deductions, as that has the effect of reducing taxes otherwise going
to the government. But to overstate income? Why would the government care if
you wanted to pay more tax?
Because
folks, 999 times out of 1000 that is not the reason someone overstates income.
People do
this to tap into the tax-credit-money-goodies in the tax Code. Most credits
will reduce your tax, but when you get down to zero tax the credit ends. There
are some exceptions. The main one, of course, is the earned income credit,
although in recent years the government has added the American Opportunity
(usually called the college) and the child tax credits.
The
government will send you a check.
The earned
income credit has the peculiar feature that the credit increases (as does your
refund) as your income increases – up to a point, of course, and then the
credit goes away.
I have
reached a point in practice where I simply do not accept a client with an
earned income credit. Chances are they could not afford my fee, granted, but I
have a bigger issue: as a professional preparer, I take on additional penalty
exposure by signing a return with this credit. I am “supposed” to perform extra
due diligence, such a verifying that there is a child in your house. I have
options other than parking across the street from your place overnight to
verify your comings and goings, though: I can look at your kid’s report card
(if it shows an address) or a doctor’s bill (again, if it shows an address).
Sure, pal.
You know what I am not going to do? Prepare your return, that is what I am not
going to do.
Unless I
have known you for years, and I know that you have had a financial reversal.
That is different. My due diligence has already been done and over several years.
There are
unscrupulous preparers who do not observe such niceties. One could set up a
temporary storefront, crank out a thousand make-believe, earned income/American
Opportunity/child credit tax returns, charge a usurious fee (refund
anticipation loans are sweet profit), skip town and enjoy the summer at a nice
beach.
I knew one
of these guys, although his schtick was made-up deductions more than false tax
credits. You automatically had business mileage if you were his client. It did
not matter if you owned a car.
Oh, did you
know that is one way for you to get audited? If the IRS looks at your preparer,
your odds of also being audited go up astronomically.
I am looking
at a case from my hometown – Tampa, also known as the tax-fraud capital of the nation.
Our
protagonist (the “Tax Doctor”) prepared a 2007 return for Shakeena Bryant. She
brought a W-2 for less than $200 from Busch Gardens and information regarding
her kids.
You are not
going to get much of a credit with $200 worth of income.
But the Tax
Doctor had a solution: report additional income from a business.
So she went
out, got a business license for auto detailing and returned with it to his
office the same day.
He then put
a bit over $18,000 auto-detailing income on her return.
I suppose
business licenses in Tampa also allow one to travel back in time.
Wouldn’t you
know she got audited?
The IRS
asked her about the auto detailing business.
She told the
IRS she did not have an auto detailing business.
The IRS then
wanted to talk to the Tax Doctor.
He explained
that he “reasonably” relied upon her statements and exercised “due diligence.”
He had that license, for example, and two pages of notes. He may also have had
a soiled napkin from Dunkin Donuts, but I am not sure.
Out comes the
preparer penalty - $2,500 of it.
Then the Tax
Doctor – not knowing when to walk away – filed suit to get his $2,500 back.
This was a
really bad idea, as it allowed the IRS to depose Ms. Bryant and the friend who
accompanied her to the Tax Doctor’s office that day.
Both testified
that the business income idea was his.
The Tax
Doctor fired back: he observed the due diligence rules, meaning that he should
not be penalized. Why, he had a business license and two pages of notes in his
files!
He had a
point.
The Court also
made a point: Ms. Bryant never talked about an auto-detailing business until he
brought up the need for more income to drive the tax credit. Perhaps a
reasonable preparer would have asked for documentation …. bank statements,
receipts, FaceBook postings, State Department leaks. Folks, it is acceptable for a preparer to use
his/her skepticism-radar.
He was
reckless.
The Court
found intentional disregard of his preparer responsibilities and sustained the
penalty.
My thoughts?
Very little
patience. The Tax Doctor got off easy.
