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Is "fudging" on the annual income tax returns OK?

 

Sure, it’s easy to overlook some tip income, ignore a portion of the operation’s receipts, or pad a few of the restaurant’s expense payments.  Fudging---not to mention blatant cheating---is becoming more widespread every year. Fudging is also becoming more difficult to get away with and, if uncovered by the IRS, more expensive. 

Closing the Gap

Both Congress and the IRS are all too aware of the growing “tax gap,” a term used to describe the disparity between the taxes owed and the taxes actually paid. The IRS attributes the gap to a variety of problems ranging from taxpayer confusion to intentional taxpayer underreporting and overdeducting. Prodded by our lawmakers, the IRS is trying to close that tax gap.

 Even before the IRS’s increased 2006 enforcement budget kicked in, the agency collected a whopping $47.3 billion in enforcement revenue, which included unpaid taxes, penalties, and interest.

Reducing Audit Risk

Today, it really doesn’t make sense to completely ignore those annual taxes or to try and fudge the tax bill. After all, it is possible to avoid becoming an audit target and to win your case before the IRS.  Failing to convince the auditor does not necessarily mean paying up; rather, it is the beginning of an appeals process where no additional taxes need to be paid until the matter is resolved or the appeals exhausted. Considering this process, why do so many of us feel that the only way to achieve a low tax bill is through omitting, cheating, or committing outright fraud?

Admittedly, the tax laws are both complex and confusing, leading to different interpretations and opening up many “gray areas” that every restaurateur can take advantage of. Scheming to benefit from loopholes and those gray areas to produce the lowest possible tax bill is legal. Going one step further---documenting any oddball deductions and attaching explanations to the return---greatly reduces the risk of becoming an audit target.

If further arguments against fudging are necessary, consider the IRS’s long memory and the penalties they can assess. There is no statute of limitations on fraud---or excessive fudging. In addition to penalties for failure to file and accuracy-related consequences, the IRS requires the payment of back taxes, interest, and penalties even when inadvertent errors are discovered.

Playing it Smart

The risk of getting caught fudging is not great. Despite the IRS’s emphasis on closing the tax gap and its increasing success at enforcing our tax laws, the actual numbers would seem to indicate that the odds of being caught are slim. Despite a steady increase in the amounts budgeted for enforcement, the IRS’s audit rate for small businesses remains at less than one percent. For incorporated food-service operations with assets above $10 million, the audit rate is only 20 percent.

But take note: while fewer restaurateurs may be selected for audit, those audits often result in bigger gains for the IRS. The agency is armed with an extensive guide to restaurant operations, a guide that tells auditors where errors are most likely to be found. And recently the IRS targeted a small number of businesses operating as S corporations or Limited Liability Companies (LLCs). The information garnered from those audits will enable the IRS to better target other businesses operating as these entities.

With all of those gray areas to exploit, all the loopholes in our tax laws, and additional time in which to strategize, it makes little sense to run the risk of being caught fudging. Plus, current tax laws penalize not only errant taxpayers, but also those who prepare their returns. With the help of a skilled but honest tax professional, you can prepare a smart and safe return, taking advantage of every legitimate tax break---and avoiding the IRS’s doghouse.

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