Cheating. It’s a morality question we talk about with our kids, our work colleagues, and even with ourselves. It is OK to cheat. In a recent poll, 10% of Americans say it’s OK to cheat here and there on your taxes and the number of people that say it’s OK to cheat is up 3.5% versus one year ago. In fact, in a Credit Karma survey that interviewed 2,000 people, only 6% of the people actually confessed to the fact that they have cheated on their taxes in the past. So, what’s the number one reason that people cheat on their taxes?
Let’s talk first about what cheating really means. There is a big difference between tax avoidance and tax evasion. Tax avoidance is perfectly legal. These are strategies such as using your 401(k), tax deductible IRA’s, pension plans, health savings accounts, and many other legitimate legal tax strategies that you can use under the current tax code. Tax evasion is an entirely different animal. When you have people who get cash tips, such as a bartender or a hairstylist, and they choose not to report the cash, that is where tax evasion occurs. Someone writes you a check for your business services and you choose not to report the check in your business. You get rental checks for your property and claim that you couldn’t rent the property. You give $100 of goods to your local Goodwill and just simply add a 0 to make it $1,000 when you file your tax return. These are all examples of tax evasion.
People cheat for lots of reasons today. Some people are angered over the recent 2018 tax changes that either limited or eliminated tax deductions that were very helpful for people in the past. One great example of this is from 2016 which was used for unreimbursed employee deductions in prior years. If you were in a sales job with a company that would not reimburse for real business expenses such as mileage or entertainment, those expenses could potentially be deducted on your tax returns in your itemized deductions. That deduction no longer exists anymore.
Some people cheat because they are frustrated over the complexity of the system, so they plan to play dumb. This means that the tax code is well over 20,000 pages so they may take a business deduction and go under the auspice that “I just didn’t realize this is how the tax code works” and take their chances if they get caught. Or, they may reimburse themselves from the 529 plan they set up for their child and convince themselves that the money is being used for the benefit of the minor. Later, they will say they didn’t understand the rules of what the 529 plan can and cannot be used for when it comes to the expenses of a minor.
Some taxpayers are just brazen. They either don’t file tax returns altogether or they flat out create deductions that aren’t real and say “come catch me.” The number one reason people cheat on their taxes is that they simply realize the IRS is getting smaller and smaller and they just don’t think they will get caught by the IRS. It’s a numbers game. Ten years ago, there were almost 25,000 IRS auditors and fewer than 140,000,000 tax returns. Today, there are more than 140,000,000 tax returns and now slightly above 9,500 IRS auditors. This means the average auditor is responsible for more than 14,000 tax returns. 14,000!!!
We could argue all day about whether the tax system is fair. More than half of the Americans in the United States pay no tax at all, so what are they going to complain about? The Top 10 to 20 percent of people who pay most of the taxes are feverishly talking to attorneys, accountants, and financial advisors to find every strategy they can to get to Romney rates and pay 15% or less on their taxes. Some people have given up and just plan to convince themselves that playing in the grey is the fair way to do it. Will we ever get to a simple system with a flat tax? Only time will tell, but with a shrinking IRS you can place a large bet that looting within the tax system will continue to happen until there is a major change.