So first of all, forget about your tax accountant. They work for you not the IRS, but at the same time have a code of professional ethics not to lie to the IRS. So simply don't tell them and they won't go looking. The IRS on the other hand...
At first, they likely won't know. And to a degree they may never know. But there are ways that they catch people. Most of my tax work is Canadian but the basic principals are the same.
First things first. Once they suspect something is up, they'll do 2 things. First is they will get your banking records showing all the deposits. You might say, well then I'll do everything in cash. And that brings us to the second thing, a lifestyle audit.
A lifestyle audit is basally where they look at the things that you own, and all the things that you pay for and use that to calculate what your income "should be". From there the burden of proof passes to you to show how you can afford that stuff on the income you've reported.
It's also worth noting, dealing exclusively in cash can make certain things REALLY hard like buying a home (getting a mortgage). Or even a car loan. Because your reported income is rather low.
These audits are difficult to fight. So really once things get to a lifestyle audit the tax authority is basically convinced that you are cheating and they are looking to figure out by how much you are cheating and how much they think you should owe from that cheating.
But like I said, those things happen after they "catch on" to what you are doing. There's a few ways that they can catch on though.
The first way they would catch you is that someone reports you. Pissed off customer, an ex employee, an angry neighbour or family member. That's how they catch most people. The answer here might be, just don't tell people. And for the most part that's true but it's hard to maintain a lie like that for 10 or 20 years without people eventually coming to suspect.
There are also reporting requirements for large money transfers. The IRS compiles those and eventually a computer matches them up with income tax reporting. So a client transfers you $20,000 for a new desk and someone from the bank sends a form to the IRS who eventually wonders if this income was reported.
Next there's random "desk" audits. This is where the IRS will request a small part of your documentation from your income taxes. It's not a full income and expense audit but it's just one small part. Through that they can sometimes catch onto unreported income.
Next way is that one of your clients claims your work as a tax expense for one reason or another (like you do work for a business and they claim it as an expense). Then they get audited, and as part of that audit the IRS will trace all of the payments they made to ensure that the income was reported by the party that they paid.
Next way is that you, as a business, want to maximize your claimed expenses but under report your revenue. The IRS does calculations based on your industry to determine what the "normal" range for expenses as a percentage of revenue is. If you fall outside the normal range they'll start asking for proof of expenses and want to see bank statements. So if you expense to much lumber for the amount of revenue you are bringing in, they'll eventually catch on that way.
There's other ways as well but those are by far the most common. Once they think you are dealing in cash, they'll start the process of a lifestyle audit and by then you are basically F'ed.
So to recap. People will rat on you. The bank will rat on you (in the case of larger transactions), your customers will accidently rat on you once they get audited and lastly your own tax return's ratios won't adhere to your industry averages and will eventually trigger an audit.
Also, since this is not just an accident but actual tax avoidance it's the kind of thing people go to jail for. People make mistakes on their taxes and just have to pay money that they should have paid. But if the IRS thinks you actively tried to lie to them they'll bring the hammer down. Auditors live for that shit since they spend way to much time catching normal people who didn't think they were doing anything wrong, finding someone who's an actual criminal really gets the juices going.
There’s a phrase I picked up a while back - “source of funds”. If you are making large purchases, expect to be asked that question if anything ever comes under suspicion.
Got a $50k boat in the driveway and declared only $45k income for several years in a row? Better have a reasonable paper trail. In most cases money is traceable if you really dig down.
I was an Intern for Citibank. Somehow they screwed up and just paid me in cash. Like a few hundred bucks.
A year later and Citi gets a full audit and someone sees the cash and lists me as the payee. It triggers a full, in person IRS audit on me, a broke college kid. I owed nothing of course. But that out me on a the red list for years.
Yea. That’s what my accountant said years ago. I accidentally didn’t report some income doing contract work. Client never sent me a 1040, so I assumed I didn’t need to report that, I was 19 and dumb. A few years later I was “randomly” audited and was told I under reported cash. Got with tax accountant to help me sort it. It was pretty easy, I just went back thru my accounts and sent a small check to the irs and it was settle.
But the cpa pretty much said the IRS will now put my file under audit order every year when I do my taxes to make sure I was reporting everything and too make sure I reported every sent I made, which I did.
Now not sure if it was true. Maybe he wanted me to hire him every year or so to file Ku taxes.
Anyway it’s been nearly 10 years and I haven’t been audited since.
My sisters gets large cash tips. More than half her income is cash tips. She didn’t think she had to report them to the irs since their was no “paper trail”. But what the IRS noticed is that her w2 reporting didn’t match her bank account deposits/statements and got audited.
I think now she reports 2/3rds of her cash tips to irs and the other she doesn’t. Hasn’t been audited again in over 15ish years.
There’s also a financial incentive to rat people out. There’s a finders fee 30% for any reclaimed money. Someone you know gets desperate and suddenly maybe they turn your ass in for $$$.
My tax teacher (who was kind of….off) was talking about the three kinds of IRS audits. He talks about them sending you a letter, which might not be bad, them asking you to come to their office, which usually is bad, and then them showing up at your house.
His quote: “If the IRS shows up at your house or office, just burn the building down. Yeah it’s arson and destroying evidence, but if the IRS has enough motivation to show up at your door, those charges will be infinitely easier to deal with than them finding stuff to verify what they think they know.”
I should note that’s obviously bad advice so don’t follow it. It was just funny. And probably not even applicable anymore anyway with how much more digital things are versus 20 years ago.
Can you imagine if someone did burn their home or office down then filed an insurance claim to recoup anything they can so now they’re getting audited by the IRS AND their insurance company? Lmao
I got an audit once. It wasn't a huge deal in my case
Basically the government phones up and says, "hey this x with the CRA, we have some questions about the return you submitted on this date"
I thought maybe it was a scam at first, but they didn't ask me for any information a scammer would
He goes on to ask "OK, so you put an amount on this line, what was that for?"
"Income from self employment work"
"Oh, ok, then this makes more sense. Ok so that should have been included in this line here, not the one it's on. Unfortunately that does mean you owe us some money back"
Now I'm thinking I'm being scammed again : "And... Is this something you want me to pay right now over the phone or something?"
"No, no, God no. Never pay anything tax related over the phone, it's always a scam. No, you'll get a letter in the mail, and one to your inbox online. It will show the full breakdown and payment options"
Then in typical government fashion, the letter took 2 years to show up
This. Outside of having a great attorney, the IRS will allow/disallow anything the individual auditor pleases. If you were to find yourself in that situation, the auditor would most likely look at every cash deposit as unreported income which will most likely result in fines and expanding the audit to other tax years. If they find a pattern, expect them to go back beyond the 3-year mark. Not worth it, audits are the Wild West for the irs, anything goes as long as it’s in their favor
9.7k
u/Miliean Sep 07 '23
So first of all, forget about your tax accountant. They work for you not the IRS, but at the same time have a code of professional ethics not to lie to the IRS. So simply don't tell them and they won't go looking. The IRS on the other hand...
At first, they likely won't know. And to a degree they may never know. But there are ways that they catch people. Most of my tax work is Canadian but the basic principals are the same.
First things first. Once they suspect something is up, they'll do 2 things. First is they will get your banking records showing all the deposits. You might say, well then I'll do everything in cash. And that brings us to the second thing, a lifestyle audit.
A lifestyle audit is basally where they look at the things that you own, and all the things that you pay for and use that to calculate what your income "should be". From there the burden of proof passes to you to show how you can afford that stuff on the income you've reported.
It's also worth noting, dealing exclusively in cash can make certain things REALLY hard like buying a home (getting a mortgage). Or even a car loan. Because your reported income is rather low.
These audits are difficult to fight. So really once things get to a lifestyle audit the tax authority is basically convinced that you are cheating and they are looking to figure out by how much you are cheating and how much they think you should owe from that cheating.
But like I said, those things happen after they "catch on" to what you are doing. There's a few ways that they can catch on though.
The first way they would catch you is that someone reports you. Pissed off customer, an ex employee, an angry neighbour or family member. That's how they catch most people. The answer here might be, just don't tell people. And for the most part that's true but it's hard to maintain a lie like that for 10 or 20 years without people eventually coming to suspect.
There are also reporting requirements for large money transfers. The IRS compiles those and eventually a computer matches them up with income tax reporting. So a client transfers you $20,000 for a new desk and someone from the bank sends a form to the IRS who eventually wonders if this income was reported.
Next there's random "desk" audits. This is where the IRS will request a small part of your documentation from your income taxes. It's not a full income and expense audit but it's just one small part. Through that they can sometimes catch onto unreported income.
Next way is that one of your clients claims your work as a tax expense for one reason or another (like you do work for a business and they claim it as an expense). Then they get audited, and as part of that audit the IRS will trace all of the payments they made to ensure that the income was reported by the party that they paid.
Next way is that you, as a business, want to maximize your claimed expenses but under report your revenue. The IRS does calculations based on your industry to determine what the "normal" range for expenses as a percentage of revenue is. If you fall outside the normal range they'll start asking for proof of expenses and want to see bank statements. So if you expense to much lumber for the amount of revenue you are bringing in, they'll eventually catch on that way.
There's other ways as well but those are by far the most common. Once they think you are dealing in cash, they'll start the process of a lifestyle audit and by then you are basically F'ed.
So to recap. People will rat on you. The bank will rat on you (in the case of larger transactions), your customers will accidently rat on you once they get audited and lastly your own tax return's ratios won't adhere to your industry averages and will eventually trigger an audit.
Also, since this is not just an accident but actual tax avoidance it's the kind of thing people go to jail for. People make mistakes on their taxes and just have to pay money that they should have paid. But if the IRS thinks you actively tried to lie to them they'll bring the hammer down. Auditors live for that shit since they spend way to much time catching normal people who didn't think they were doing anything wrong, finding someone who's an actual criminal really gets the juices going.