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Tax cheats can land spouses in hot water

By Claudia Buck, McClatchy Newspapers –

SACRAMENTO, Calif. — An anonymous letter arrived recently from a worried spouse. The woman said she was “terrified” that her husband’s tax cheating would land them both in federal prison. Her husband, she said, didn’t report all their rental property income because “everyone does it.”

What, she asked, happens to “tax cheaters like my husband” and what are my options?

With this year’s tax filing deadline at hand, her questions are very real. To get some answers, McClatchy Newspapers talked with Internal Revenue Service spokesman Jesse Weller about tax fraud in general and about spousal obligations in particular.

There’s no question that tax fraud — failing to pay what you owe to state and federal tax collectors — is a big problem.

According to the IRS’ most recent data from tax year 2006, an estimated $385 billion in tax goes unpaid by Americans each year.

“Taxpayers who cheat are gambling that they won’t get caught,” said Weller. “That’s a losing proposition for the cheater, and it also hurts the vast majority of Americans who file honest and accurate returns, pay their fair share and have to make up the difference.”

There are many ways that individual taxpayers avoid paying their share. One of the most common: deliberately underreporting income, such as restaurant tips, gambling winnings, rental income and cash transactions.

“It’s been around as long as people have done taxes,” said Weller.

Underreporting income typically occurs with cash transactions where there’s no paper trail, such as a W-2 form for wages or a 1099 for interest. Often it’s small businesses or self-employed individuals who have a lot of cash transactions with customers. It could be the independent contractor who is paid by cash for working on your house, or the landlord who fails to report all the rent received from tenants.

Other types of tax fraud:

—Overstating the amount of deductions, including charitable contributions, mortgage interest, and medical or employee business expenses.

—Keeping two sets of books. One set of accounting records is real and reflects the accurate amount of income/expenses; the other is falsely used for tax purposes.

—Claiming personal expenses as business expenses. It could be luxury vacations, $250 dinners or Las Vegas show tickets — anything that gets written off as a business cost, but is actually a personal expenditure.

—Hiding or transferring assets, typically those held in foreign or offshore accounts. In an effort to improve disclosures, the IRS has a new Form 8939 for taxpayers to report their foreign financial assets.

By definition, tax fraud is when a person willfully or intentionally avoids reporting their full income or fraudulently boosts their deductions.

It’s not the same as negligence, such as when someone forgot to list a W-2 on a tax return. “That’s an error, not fraud,” said Weller. In that case, the taxpayer might get an IRS letter stating the true amount owed, plus interest and penalties.

For married couples who file taxes jointly, the hazards of tax cheating vary.

Generally, spouses who file jointly are equally liable for any tax due. Even after a divorce, if an audit reveals prior tax fraud, both parties would be held responsible for the full amount of tax owed.

In certain circumstances, a husband or wife may not have to pay the tax, interest and penalties on a joint return.

Under “innocent spouse” rules, if something on a tax return is amiss and the innocent spouse was unaware or “had no reason to know,” he or she may be relieved from paying the full amount owed.

Under “equitable relief,” the tax burden can be lifted in specific instances, such as if a spouse establishes that she was a victim of spousal abuse or domestic violence and did not challenge the tax return’s truthfulness “for fear of retaliation,” said Weller.

Taxpayers who are audited and found to have willfully evaded income taxes may be assessed a civil fraud penalty, or be subject to criminal prosecution.

Civil fraud can include a penalty of up to 75 percent of the tax underpayment, plus interest and other penalties. In its last fiscal year, October 2010 to September 2011, the IRS assessed more than 2,800 civil fraud penalties totaling nearly $200 million.

If convicted of criminal fraud, a taxpayer could get hit with fines up to $250,000 and up to five years in prison.

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