Every year, you save your receipts, track your expenses and - when April comes around - pay your taxes. But what if you know of someone who isn't as honest as you are? Someone who skims on their income or misreports information in order to be placed in a lower bracket.
The Internal Revenue Service (IRS) estimates that Americans underpay their taxes by about $345 billion every year, according to Barron's, the popular financial news website and magazine. In fiscal 2009, the IRS collected $48.9 billion in enforcement revenue. This process required the employment of thousands of revenue officers, agents and special agents. Unfortunately, this type of enforcement happens every year and often spans to multiple previous years. In the end, there is still a large amount of tax money that goes unpaid.
There's definitely a gap between the tax evader and the IRS. Evaders are usually exposed due to a slip-up on their part or a tip from a bystander. If you'd like to help close that gap, you can. But why should you, and how is it done?
Why Help the IRS?
Nobody likes paying more than their fair share of taxes in order to compensate for others who intentionally evade theirs. Why shouldn't tax evaders give up a portion of their incomes to provide things that benefit the general good, like roads and sewers, when you do? Reporting a tax cheat is like reporting a shoplifter - you're just asking them to pay for something they're trying to unfairly get for free.
Gather the Evidence
The IRS is not likely to pursue someone without good reason. If the time and resources are going to be spent, the odds need to be good that the efforts will result in a payoff. Besides determining who, what, where, when and why the person evaded his or her taxes, the IRS will need specific information (type of violation, availability of books or records). Having a hunch without supporting details just isn't good enough.
Also ensure that the evasion is financially significant enough. For example, stating that your neighbor failed to report a $50 babysitting earning is not going to interest the IRS. On the other hand, if you work for a large business that you suspect is underreporting its income, the IRS will likely be very interested.
Blowing the Whistle on a Tax Cheat
The IRS may pay awards in exchange for valuable information that leads to the collection of "taxes, penalties, interest or other amounts from the noncompliant taxpayer," according to the agency's website. There are various types of awards granted, depending on the evader's income level and classification (business or individual). The IRS likely chooses to focus its efforts on these larger cases because they have a higher payoff. It has also been suggested that higher income individuals have been found to cheat more frequently and for higher sums of money, mostly because they tend to earn more self-reported income.
Cover Your Assets
Fabricating a complaint in order to spite an undesirable neighbor who does, in fact, pay taxes is not a good way to get revenge. When you sign off on the IRS form providing your report, you are stating, "I declare under penalty of perjury that I have examined this application, my accompanying statement and supporting documentation, and aver that such application is true, correct, and complete to the best of my knowledge." You don't want to be found guilty of perjury.
Keep It Legal
Breaking into the CFO's office at work to get evidence to support your claim is not a good idea. The IRS doesn't want you to break the law to help find a tax cheat. However, if you are the bookkeeper for a company that is cheating on its taxes and part of your job involves working with documents that prove the company is cheating, that paperwork would be acceptable to submit to the IRS.
While the IRS wants to maintain your privacy, if the case against the person you report ends up going to trial, you could be asked to be a witness. If you're comfortable with that possibility, go ahead and put your name on the report.
Reasons Not to Report a Cheat
If your "information" is really just speculation, it's probably best to keep it to yourself. As explained earlier in this article, the IRS does not have the resources to pursue your hunch.
If you, yourself, are a tax cheat, it might be best to stay in the clear. There's nothing that says that people who submit claims of cheating by others will have their own tax returns examined more carefully. Still, it stands to reason that you wouldn't want to do anything to call IRS attention to yourself if you're not in compliance with its rules.
If you helped plan or initiate the cheating of the person you are reporting, it might be smart to think twice. If you decide to report a crime in which you took part, be prepared for the consequences, and definitely don't expect to receive a reward.
As with many government processes, there's a lot of red tape to cut through. Therefore, if you're looking for fast cash, you might want to look elsewhere. It can take several years to complete an investigation of tax evasion – and if there is no conviction, there is no award. Not only does the IRS have to determine guilt, it has to actually collect the amount owed before paying you. What's more, if the IRS determines that your tip did not "substantially contributed to the Service's detection and recovery of tax," you will not receive an award.
It's also important to note that, under some circumstances, like attorney-client confidentiality, you may not be able to report tax cheating.
If you earn a whistle blower award, it will need to be reported when you file your taxes. If you're blowing the whistle on your employer and you're not planning to change jobs, an IRS audit could make your work situation extremely unpleasant. This isn't to say that you shouldn't report someone who is cheating, but it is something to consider.
If you decide to report the person or business you suspect of cheating, use IRS form 3949-A. This form asks for basic information on the tax evader you are reporting, the types of violations you believe to be committed, the details of the violation and how you learned about it. If you do not want to fill out this form, you can also simply write the IRS a letter. If you are providing your name and want the possibility of receiving an award, also submit IRS Form 211 which is an application for the award.
The Bottom Line
Underpayment of federal income taxes (and, subsequently, state income taxes) is a serious problem. The IRS encourages people to submit tips by allowing anonymous submissions and offering generous rewards for informants who are willing to identify themselves. If you can substantiate your claims and are willing to accept the potential consequences of squealing, reporting a tax cheat can be lucrative not only for the government, but also for you.
Personal FinanceTax loopholes are shrinking, but there are still plenty of viable prospects. Get the big picture.
TaxesEvading taxes is illegal, but avoiding paying unnecessary tax is one of the keys to building wealth.
TaxesThese five famous Americans tried to dodge the taxman and got caught. Find out who they were and what they owed.
TaxesIf you can't pay your taxes, know that the IRS has many avenues for collecting what you owe.
TaxesThese tax-free zones might sound appealing, but the consequences often aren't.
InsuranceLearn about the tax implications of life insurance premiums, including when they might be taxable and whether they are tax deductible.
Investing BasicsLearn how dividends are taxed by the IRS, and understand the different types of dividend income as well as the capital gains tax rates.
Investing NewsTwo years into his first term, Mexican President Enrique Peña Nieto is following through on radical campaign promises he made to Mexican citizens for sweeping multi-industry reform.
InvestingThinking of subletting your apartment on Airbnb? Make sure that you meet your city's regulations first.
TaxesWant a picture of an organization's activities? This annual form, open to the public, sums up everything from salaries paid to missions accomplished.
The minimum amount of equity that must be maintained in a margin ...
Money earned through any illegal activity controlled by country ...
A bill passed during the administration of former U.S. President ...
Slander is the act of harming one person’s reputation by telling ...
Goods that international travelers can purchase without paying ...
Libel is publishing a statement about someone in written form ...
Despite the fact that earning dividends requires no active participation on the part of the shareholder, they do not meet ... Read Full Answer >>
Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third ... Read Full Answer >>
With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
Credit card rewards are taxable in the United States some of the time. The Internal Revenue Service (IRS) classifies credit ... Read Full Answer >>
Eligibility to collect Social Security benefits begins at age 62. Many seniors, to collect larger benefit amounts, wait until ... Read Full Answer >>
Anyone who has ever tried to purchase or sell a home has probably heard a lot about the property's fair market value, or ... Read Full Answer >>