This past week an old story returned to the surface. A tax office that handles mostly simple tax returns for a very low price and gets paid mostly cash might not be claiming all that income. A previous employee of that firm informed me over $300,000 in cash was kept in a safe in the money cage.
The final response (and I was thinking the same thing) was, “And I’m sure all that cash was reported.
Cheating on your taxes is as American as apple pie, but a whole lot dumber. If this other tax firm really has that much cash on hand and does not report all their income they lose a lot more than most people expect.
First, if they get audited and the unreported money is found you can expect more audits. This is a tax on your time and I can’t think of a more usurious tax.
Next are the penalties. Here is a sampling of the penalties that could apply:
1.) Accuracy related penalty (§6662): 20% of the assessment.
2.) Fraud (§6663): 75% of the amount attributable to fraud.
3.) Willful attempt to evade or defeat tax (§7201): Up to a $100,000 fine, five years in prison, or both. This is a felony! If they are a corporation the fine can climb to $500,000.
4.) Willfully making and subscribing to a false return (§7206): Also a felony with a fine up to $100,000, three years in prison, or both. Corporations face fines up to $500,000.
Even worse, with underreported income at those levels it is likely the IRS will seek to bar the owners from ever preparing taxes again. And my guess is they would find a few more penalties to apply to make the financial pain even worse.
He would probably make the local evening news. Clients would bolt. Clients would face greater scrutiny. There isn’t anything I find acceptable about the risk of underreporting income in their situation.
The odds of getting caught are small, however. And even if they get audited, the IRS may not find the underreported income.
And none of that matters because there is another cost to cheating on your taxes that costs more than the taxes saved even if you don’t get caught.
Why Cheating on Your Taxes Costs More Than the Tax Avoided
The first time I heard the rumor was at least a decade ago. The firm files a lot of returns. I mean a lot.
Their fee is the lowest of any firm in their service area of any size. I imagine a few guys working out of their home might do a return for less, but this firm is the lowest fee of any major player locally.
Probably 80% of the firm’s revenues are in cash with the firm pulling around seven figures of revenue annually. The owner could siphon a cool $100k off the top with no problem.
Cheating on your taxes has a hidden cost. You can’t just deposit the unreported cash into a financial institution. The IRS might be slow, but they ain’t stupid. They will find that quicker than a starving mule finds a load of oats.
If you can’t deposit the money you are left with spending it. (You could launder the money, but that has a cost, too, which is nothing more than a tax paid to a different entity.) And when you spend it you can’t look like you are spending that much. Buy a car with cash and the IRS gets a report.
I guess you could save it up for retirement, spending some here and there as not to look conspicuous.
Yet, that isn’t the real problem. The real problem is lost opportunity cost!
Let’s say the tax on this $100,000 is 40%, federal and state taxes combined. That would leave the business owner with $60,000 after tax.
Yet, if that $60,000 was invested 10 years ago in an S&P 500 index fund it would now be worth nearly three times as much! Even if we take a bit off the top for spending we still have more than $120,000 and in reality closer to $150,000! The best the unreported income can do is maintain $100,000, unless you want to risk some prison time.
Cheating on your taxes never pays! It always costs you more in the long run with serious risks in the short run. If you underreport income by up to 25% the IRS can audit you on that return for up to seven years after you file or from the due date, whichever is longer. This is up from three years when you play it straight. If the underreported income is over 25% that tax return is open for audit forever!
There is a way to profit from people who do cheat on their taxes.
When a client offers to pay cash they sometimes do so with a wink. I assume they mean that since they paid me cash I will not report it. Unfortunately, I invoice each client separately so I create a paper trail. It all gets reported. It is how a real business operates. (I’m a real business.)
It has been a long time since I was asked for a discount if I am paid cash. When I was the answer was always no. I use the Seth Godin plan: full price or free.
When purchasing a good or service I might ask for a discount if I pay cash. I remind the business owner they don’t have to pay bank transaction fees. It is a win/win for all parties involved. I never make it a tax cheating issue
Several years ago I was coming home from the office during tax season when a deer attacked my car. Hit the from wheel well. A rural body shop quoted me $800 to fix the damage. It was a really good deal.
I brought cash when I picked up my car, concerned he might not want to accept a check. Without asking, the business owner offered me a $200 discount for cash.
That was a whopping $200 discount; 25%! It was accompanied by the ol’ wink-wink. I took that to mean he would not be reporting the income. (Hey, I’m not here to judge.)
He traded his tax bracket for a 25% tax paid to me. And my savings were tax free!!! (You don’t pay tax on money you didn’t spend on a service.) By the looks of the place I don’t think his tax bracket was much higher. I enjoyed the discount, but it was still foolish on the business owner’s part if he did so just to not report a small amount of income.
Tax season is heading into the final stretch as I write this. I hope I made the case for not cheating on your taxes. It isn’t too late to file a superseding return if you left something important off your tax return, like some income.
The risks are too high for anyone serious about accumulating wealth. The math doesn’t add up. Cheating on your taxes will bite you in the tail regardless the outcome. Audits waste a lot of time and are not fun. (You can make more money, but ya can’t make more time.)
The lost opportunity cost of wasted time hiding money from the government and the lack of ability to invest all your money optimally make it real clear: cheating will always cost you.
Worse, you could have enjoyed a few posts around this blog and saved as much or more legally than you potentially saved cheating. (What are the chances traffic to this blog will spike now?)
I know you will do the right thing.
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