The single biggest business tax mistake a business can make is to willfully evade paying taxes. Individuals will also make this mistake and both the business and the individual are skating on thin ice if they think they won't get caught and punished.
Tax evasion does not include honest mistakes or errors. Evasion is what the Internal Revenue Service calls "voluntary, conscious, and intentional" conduct. It's the difference between avoidance and evasion.
Tax Avoidance vs. Tax Evasion
Tax avoidance is legal; it's what taxpayers do to avoid paying more tax than necessary. You can avoid business and personal taxes by taking deductions and credits. As long as these deductions and credits are supported by documents and within IRS and state regulations, you are avoiding, not evading, taxes. You can also avoid paying more than necessary by delaying taxes using IRAs, 401ks, and other tax-deferral methods.
Tax evasion, on the other hand, is not paying taxes by illegal methods. In an article on Forbes, Robert Wood discusses what the IRS deems to be "willful" tax mistakes. Willful tax evasion can be either a sin of commission (intentionally doing something, like paying in cash) or a sin of omission (failing to include income or failing to file a tax return).
If the IRS, or the Tax Court, deem that an act by a taxpayer is "willful," it can mean increased fines and penalties, including jail time.
Under-Reporting Business Income
Avoid under-reporting income. All business income must be reported. This requirement includes income from barter transactions and cash transactions. Another common way businesses under-report income is to avoid reporting large cash transactions by keeping deposits under $10,000. Deposits of $10,000 or more are required to be reported to the IRS.
Some businesses try to avoid issues with payroll taxes by paying employees in cash. Paying in cash usually means no withholding for income taxes and FICA (Social Security and Medicare) taxes are paid.
Over Reporting Expenses
You also need to avoid over-reporting expenses. Some of the most common ways businesses over-report expenses are:
- Reporting personal travel expenses as business expenses, such as taking a spouse on a business trip and claiming the spouse's expenses as business expenses, or claiming personal miles as business miles.
- Taking an unjustified deduction for home office space
- Claiming other personal expenses as business expenses.
Not Reporting Sales and Employee Tax
The most common way that businesses fail to report taxes are the failure to report sales taxes and payroll taxes. These taxes are called "trust fund" taxes because they are collected from others—customers, in the case of sales taxes and employees in the case of payroll taxes. The money collected is held in trust by the business, to be reported and paid to the appropriate taxing authority.
Willfully using these taxes to fund a business instead of reporting the collection and paying when due is tax fraud.
Lifestyle and Tax Fraud
One of the ways businesses are caught in tax fraud is to have a lifestyle that's not aligned with their reported income. A high-flying lifestyle indicates that business income hasn't been reported, in most cases.
In a 2014 bankruptcy case, Hawkins vs. The Franchise Tax Board of California, the Hawkins family lived a "truly exceptional" lifestyle while claiming they were bankrupt. The 9th Circuit Court and the California Franchise Tax Board determined that "maintenance of a rich lifestyle after their living expenses exceeded their income constituted a willful attempt to evade taxes."
Any business can make a legitimate mistake. But remember that ignorance of the law is no excuse. A business owner has an obligation to know—and abide by—the law, or face the consequences.
General Fraud Statutes and Penalties
According to the Internal Revenue Service:
Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
Other fines and penalties are imposed for willful acts, such as
- Failure to collect or pay tax
- Willful failure to file a return
- Fraud and false statements (you must sign your tax return, attesting that all statements in that return are true)
If acts are deemed to be "willful," the court may deem these acts as felonies or misdemeanors and may result in heavy fines and imprisonment.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.