As a business owner, you may find it increasingly difficult to file an accurate tax return. The tax code is complicated, and it’s not unusual to a mistake when filing your business taxes.
However, if you intentionally post incorrect data in your tax return, you may be guilty of tax fraud. The potential penalties for tax fraud can be substantial, and a tax fraud conviction may impact your ability to do business moving forward.
Use this discussion to understand what tax fraud is, how it can impact you professionally, and how to protect yourself from this risk.
To calculate your taxes, check out this calculator.
What is fraud?
Fraud is broadly defined as willful intent to deceive, and business owners may be victims of fraud. In a business setting, fraud can occur when two or more people collude and bypass company controls.
Assume, that Bob owns Riverside Dining, and Bob’s restaurant manager is responsible for ordering meat, fish, and other food. The manager places orders with vendors and verifies that the food is received before Bob pays each vendor.
The manager begins to create fake vendor invoices, which include a payment address that the manager personally controls. The manager sends the invoices to Bob, and tells the owner that the food was received. The restaurant’s administrative assistant colludes with the manager and generates a check for Bob to sign and mail to the fake address.
This type of fraud, referred to as a fictitious payee fraud, is a willful act to deceive the business owner and steal funds.
Mistakes vs. fraud
Tax fraud is slightly different. While this type of fraud may not involve collusion, it is an intentional act.
The IRS defines tax fraud as: “intentional wrongdoing, on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Tax fraud requires both a tax amount that is due and fraudulent intent.”
Fraud requires intent, and a taxpayer who makes an honest mistake is not committing fraud.
To illustrate a tax fraud, consider the following example:
Year-end equipment purchase
To stimulate economic activity, lawmakers sometimes change the tax law to allow a business to deduct 100% of the cost of a new asset, such as machinery or a piece of equipment.
Depreciation is the amount of expense posted as an asset is used to generate revenue, and depreciation expense is normally posted over five years or longer. If a business can deduct 100% of the depreciation expense in the year of purchase, company expenses are higher, and the tax liability for the year is lower.
To take advantage of the new tax law, Bob records $10,000 in depreciation expense for a commercial oven purchased in the last week of 2018. The $10,000 expense represents 100% of the oven’s purchase price.
Riverside Dining’s tax returns are audited a year later, and the IRS auditors determine that the commercial oven purchase didn’t occur until 2019. Bob’s bank account indicates that the oven was paid for in late January of 2019 and that the oven was delivered in early February.
Bob has intentionally misstated his tax return by recording the oven purchase in 2018’s accounting records and taking the tax deduction in that year.
Type of fraud
The burden of proof for tax fraud is on the Government. In this case, the IRS believes that the tax return (which includes the oven’s depreciation expense), the bank records and the oven’s delivery date all prove that Bob intentionally filed a false tax return.
Bob may be accused of either civil fraud, or criminal fraud, and the difference is based on the degree of proof required. In a civil fraud case, the Government must prove fraud by clear and convincing evidence, while a criminal case requires sufficient evidence to prove guilt beyond a reasonable doubt.
If the Government believes it can prove a criminal case, it may also pursue a civil fraud case.
In a civil case, the IRS will review the return and assess the correct tax liability, then impose civil penalties based on the dollar amount of the fraud, and other factors.
A criminal fraud, on the other hand, results in punitive action, and the penalties include fines and possible imprisonment. The criminal case may also require restitution payments.
Finally, a civil or criminal conviction is a matter of public record, and a fraud conviction can be professionally damaging to a business owner. An owner may not be able to attract new business, or obtain bank loans, as a result of a conviction.
In spite of your best efforts, you may file a tax return that contains an error, and the risk of an error increases as the tax code becomes more complicated. Also, keep in mind that, as your business grows and generates more revenue and profit, you are more likely to have your company tax return audited.
How can you protect yourself from an allegation of tax fraud?
- Record keeping: Your first line of defense is to keep organized and accurate records. Use software to generate both your financial statements and your tax return, and store your information on the cloud. This approach makes it easy to access and review your records.
- Hire an expert: Have a CPA or an enrolled agent prepare your tax return. Enrolled agents are not necessarily CPAs, but they have passed a set of IRS exams on tax preparation. The person you hire to prepare your return must work as a tax preparer each year, and stay on top of changes in the tax code.
- IRS notices: Many business owners don’t follow up quickly on IRS notices, and this can create more problems down the road. If you receive a notice, you and your tax preparer should contact the IRS by phone immediately. This type of quick follow up shows that you’re trying to comply with IRS requirements and can help you avoid penalties and fees for late payments.
- Dealing with an IRS audit: If the IRS decides to perform an audit, make sure that your tax preparer is present during the audit. If you have prepared the tax return on your own and you’re under audit, have a CPA review your return before the audit. You can also ask the CPA to be present during the audit.
Generally speaking, you should avoid preparing a business tax return on your own. Hire an expert who stays up to date with the current tax code and doesn’t meet with an IRS auditor without your tax preparer or a CPA present.
Scams targeting businesses
Business owners face the growing threat of cybercriminals, who attempt to steal tax data, and you should take steps to reduce the risk of identity theft.
The IRS reported approximately $46 million in fraudulent refunds last year, and over 2,200 tax returns involving identity theft. To protect yourself, have your taxes prepared by a CPA, or a tax preparer who is an Enrolled Agent at the IRS.
To keep your business protected year-round consider enrolling in a program that consistently monitors the dark web for your business information and notifies you when a threat is detected.
You should also ask for your preparer’s Preparer Tax ID Number, which identifies the preparer at the IRS.
Avoid clicking on links or downloading email attachments that claim to be from the IRS, and file early, to reduce the risk of stolen tax information. Finally, protect your Identity Protection Pin, which is the six-digit code that identifies your business with the IRS.
Stay on track
Business owners have dozens of tasks to manage, and preparing your company taxes should be left to an expert. To protect yourself from an allegation of tax fraud, keep good records, hire a tax preparer, and get help if your business tax returns are audited.
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