How to Avoid Jail When You Owe Back Taxes
A very rich person once said, “We don’t pay taxes. Only the little people pay taxes.”
Her name was Leona Helmsley. Guess what? She went to jail for not paying taxes.
So can you, though the odds aren’t as high as Helmsley, the hotel tycoon who was nicknamed “The Queen of Mean.”
U.S. tax laws apply to everyone, and the Internal Revenue Service has thrown plenty of non-tycoons in jail.
They were convicted of tax fraud or tax evasion. There are legal distinctions, but both essentially mean you did not pay the government what you legally owed.
The tax code is so complicated that many times a person doesn’t even realize they are cheating the government.
If it’s an honest mistake and the correct amount of tax is paid, you don’t have to worry about prison. Despite its ruthless reputation, the IRS will not prosecute you if you don’t have enough money to pay your tax.
You can get an extension and a payment plan. So you will eventually pay but it will be in installments.
If you owe a lot, you might even be able to work out an offer in compromise and settle for less than the full amount. Willie Nelson was charged a back debt of $16.7 million in 1990 and eventually worked out a deal that cut his tab to $9 million.
The most important thing is to file your return on time whether you have the money or not. Late filing fees are stiffer than late payment fees and filing on time indicates to the IRS that you are not trying to pull a fast one.
When it comes to that, people have been trying it since the IRS began collecting taxes in 1913. The more money someone has, the more detailed the scheme usually is.
Wesley Snipes earned $40 million making movies between 1999 and 2004. He said advisors told him that only foreign-sourced income was taxable. It was a fraudulent scam to avoid $7 million in taxes and it didn’t work.
Snipes was convicted of three counts of failure to file a return. The man who starred as Passenger 57 in a movie became prisoner No. 43355-018 for three years at the McKean Federal Correctional Institution in Pennsylvania.
Paul Manafort, the former chairman of Donald Trump’s 2016 presidential election campaign, was found guilty of tax fraud in August 2018 and faced up to 80 years in prison.
And in one of the most famous tax cases in U.S. history, Helmsley was convicted of tax fraud from 1983 to 1985. She used company funds to pay for personal luxuries like a $45,000 silver clock shaped like the Helmsley Building in Manhattan.
A former housekeeper testified that Helmsley told her, “We don’t pay taxes. Only little people pay taxes.”
The jury thought differently and Helmsley was sentenced to 16 years in prison.
The average person who cheats the IRS doesn’t have advisors or off-shore accounts or $45,000 silver clocks to hide. There are simpler ways to not fully report income, like claiming they have more children than they really do, not listing the sale of property or making excessive charitable donations.
If someone says they earned $50,000 and donated $42,000 to charity, the IRS is going to wonder how that person lived on $8,000 that year.
Millions of people make money working side jobs that often pay in cash. That is harder for the IRS to track, but jails are filled with people who gave it a try.
Say you’re a plumber and work some off hours as a handyman. You make $200 or so every week, put it all in a savings account and don’t report it on your tax return.
All is well until the IRS gets a 1099-MISC form from Ace Construction Co. that says you were paid $1,800 as an independent contractor on a project.
Or the IRS gets a 1099-INT form from the bank stating you earned $19.38 in interest on a savings account.
That sets off a red flag and you get audited. You don’t know what the IRS has discovered, so you deny underreporting your income.
An auditor gets your bank records and finds that you’ve had a savings account for 10 years that had as much as $30,000 in it.
Your case is turned over to the IRS’s Criminal Investigation Division, you are convicted of tax fraud and you end up sharing a jail cell for four years with someone far less admired than Wesley Snipes.
On top of that, you have to pay all those back taxes with a 75% fraud penalty tacked on.
Is trying to save a few grand in taxes worth all that?
Now let’s talk about what to do if you are audited by the IRS.
If you think it is, your chances of getting caught increase with your income bracket. In 2015, the IRS audited only 0.59% of filers who made less than $200,000.
Those who made $1 million or more were audited 4.375% of the time. That was about half as many as were audited in 2010 despite the fact that the number of returns increased 5% in that time.
That reflected almost $12 billion in IRS budget cuts, and the trend has continued. The IRS audited just 0.6% of all returns in 2016, which was the lowest percentage since 2002.
So the odds are in your favor if you cheat, but that doesn’t mean nobody is getting caught. Out of about 1 million audited returns in 2016, the IRS launched 3,395 criminal investigations and got 2,672 convictions.
Any action you take to evade an assessment of tax can get one to five years in prison. And you can get one year in prison for each year you don’t file a return.
The statute of limitations for the IRS to file charges expires three years from the due date of the return. But that clock doesn’t start ticking until the return is filed.
In other words, if you didn’t file a 2013 return and think you’re out of the woods, you haven’t even entered them yet. And if an audit reveals you concealed more than 25% of your income, the statute of limitations to file charges doubles to six years.
Once taxes have been assessed, the IRS has 10 years to collect them before time runs out. It has considerable resources to pursue legal action, including garnishment of wages, interest fees, penalties and, finally, jail.
If you are audited, the best thing to do is fully cooperate. Actually, the best thing to do is fill out your tax return as honestly as you can and file it on time.
But if you ever fail at that and the IRS comes snooping, don’t destroy any records since the IRS can acquire most financial records anyway.
You’ll definitely want to hire an attorney. And if you go to trial, don’t say that only little people pay taxes.
Little or big, the IRS will prove differently.