What Really Happens If You Cheat on Your Taxes?

Ralph Estep Jr.:
00:00

Have you ever fudged a few numbers on your tax return? Maybe claimed an extra deduction here or there that you weren't totally sure you qualified for? Well, the question for today is: what would happen if the IRS caught you cheating on your taxes? Could you end up in jail? With all the talk in the news about federal tax charges, and listen, unless you live under a rock, you hear about this every day. Let's get into a frank discussion about how you could also be cheating on your taxes and potentially end up in hot water. And nobody wants to be in that position with the IRS.

Ralph Estep Jr.:
00:36

Welcome to another episode of the show. Today we're talking about something that makes most people a little nervous, and that's cheating on your taxes. If it doesn't make you nervous, it should. To know that the infamous gangster Al Capone was ultimately convicted of tax evasion, and that's what landed him in federal prison. I've had a few clients who spent time in federal prison, of course not because of work I did, but they all tell me the same thing. "Ralph, you don't want to go to prison." And I'll tell you what, I don't want to go to prison. So, let's figure out how to avoid that outcome altogether. That's what we're going to be talking about on today's show.

Ralph Estep Jr.:
01:13

Now before we dive in, I want to thank you for joining me today. It's always an honor to have you here. If you're new to the show, this podcast is all about mastering your finances from a Christian perspective. My goal, my ultimate goal, is to help you gain financial freedom without having to compromise your faith. Now yesterday we had a great discussion about the hidden cost of homeownership. If you missed that episode, be sure to go back and listen. It was full of some practical tips for budgeting when you're a new homeowner; we've all been there before. And make sure you tune in tomorrow, when we tap into the question of whether or not you should put money down when you buy a car. Spoiler alert: my answer might surprise you. My wife always says I'm certainly full of surprises these days.

Ralph Estep Jr.:
02:01

Alright, well, let's talk about cheating on taxes. What a great topic. Everybody can get in; that's a touchy subject. So, I'll start with our Bible verse of the day, and it comes from the book of Proverbs Chapter 13, verse 11. It says this: "Dishonest money dwindles away, but whoever gathers money little by little makes it grow." That's one of the things we should all want to do. As Christians, we know that integrity and honesty should guide all of our actions. That includes how we handle our taxes. But the temptation to fudge the numbers can be strong when Tax Day rolls around. I'm just like you. I don't want to pay a lot of taxes either.

Ralph Estep Jr.:
02:40

So here's the scenario I sometimes hear from listeners: you've got a side business going, maybe it's handyman work or buying items from yard sales and reselling on eBay or some other online site. You bring in a few thousand dollars over the course of the year. Do you claim that extra income on your taxes? Or do you just, well, forget to mention it? Seriously, Ralph, nobody claims those things. Are you telling me that this is tax evasion? Maybe you rationalize it by saying it's just a little extra cash, Ralph. Reporting this small amount probably won't make any difference at all. What you might not realize is that even minor fudging on your taxes can lead to major consequences if you get caught. And the IRS has gotten really good at catching tax cheats in recent years.

Ralph Estep Jr.:
03:24

So today we'll talk about five ways people often cheat on their taxes. Now this is not an exhaustive list, but these are five, and most of the time they do it without even realizing it. I'm going to explain how the IRS catches those tax evaders. And then we're going to discuss what happens if you do get charged with tax evasion. And here's another spoiler: you could end up with huge fines or even jail time. Nobody wants to go to jail. My goal today is to help you avoid the pitfalls that could put you on the wrong side of the IRS. As Proverbs says, "Dishonest money dwindles away. But when we're wise and faithful in handling money, including paying taxes properly, it can grow."

Ralph Estep Jr.:
04:03

So let's get started. Let's talk about what I feel is the most common form of cheating on your taxes. This is by far the biggest one. And that is not reporting cash income. As in our open example, one of the most common ways people cheat on their taxes is by not reporting income that was paid in cash. This can be anything from side jobs, cash tips, small business sales, gig economy work, and so on—a long list of those things. Here's an interesting fact: the IRS estimates that more than 500 billion—that's 500 with a B—in tax revenue is lost each year from unreported income. And cash income is easier to hide since there's no paper trail like there would be with a paycheck stub; many call it the black market economy. But if the IRS catches you—well, we'll get to that later in the show. But here's the thing: the IRS doesn't just take your word for what you've earned. They actively look for discrepancies that could indicate unreported income. For instance, if you deposit more cash in the bank than what your tax return shows you've earned, that's a huge red flag.

Ralph Estep Jr.:
05:06

So here's a pro tip: you better be able to account for any deposit that you make to your bank account, because often that is the first place the IRS will look if you're ever audited. Or maybe you write off business expenses that don't match the income reported; that could also trigger an audit. The bottom line is this: don't rationalize hiding cash income. Report it all, every single penny.

Ralph Estep Jr.:
05:31

Let's move on to number two. Another way people often cheat, either knowingly or accidentally (Hint, Hint), is by claiming deductions they don't actually qualify for. For instance, let's say you did some driving for your side business. The truth is, the law says you can deduct mileage, but only for miles specifically driven for business purposes. If you overestimate those miles, that's considered tax cheating.

Ralph Estep Jr.:
05:55

Here's another pro tip: use a mileage tracker to keep track of those miles. If you are audited, you'll need those records. And there are a ton of these available online. I'm not going to endorse a particular one, but go find one and use it.

Ralph Estep Jr.:
06:08

Other common areas for exaggerated deductions are business meals—you know, that meal you attributed your way to last month when you "discussed business"—maybe travel expenses, home office spaces, and many more. Tempting as it may be, don't ever claim deductions that are stretching the truth. Only claim what you can back up with documentation if you're audited. My common refrain to clients is, if you can convince your grandmother of the deduction, then it's likely okay. Because in my experience, most of us don't lie to our grandmas. But maybe again, I'm a bit naive.

Ralph Estep Jr.:
06:41

Moving on to number three, not reporting barter transactions. In some circles, it's common to trade goods and services without exchanging actual money. But did you know that bartering still counts as taxable income? Many people don't realize that, but it's still income to you. Let's say you're an accountant like me and you do tax prep for a photography friend, and in exchange, he takes professional headshots of you. It's not much to work with here, but maybe you got some good ones. Even though no money has changed hands, the value of services traded still counts as income for both parties. If you don't report bartered goods or services, the IRS sees that the same as not reporting regular income. So, you have to make sure you track and document any exchanges, so you can report their fair market value.

Ralph Estep Jr.:
07:26

So, here's another pro tip: don't do bartering at all. Charge for your services and expect to be charged for the services of others. In my humble view, this really does prevent problems down the road, not the least of which is tax issues. But I've seen this cause problems about perceived value as well. I've seen it destroy relationships; it's just better to avoid it altogether.

Ralph Estep Jr.:
07:46

Let's look at number four, and that's mixing personal and business expenses. If you're a small business owner or self-employed, it can be really tempting to blur the lines between personal and business expenses. But claiming personal expenses as business deductions is a surefire way to raise that red flag with the IRS. To avoid this pitfall, maintain separate bank accounts and credit cards for your business and your personal life, and only deduct those expenses that are directly related to your business.

Ralph Estep Jr.:
08:16

Here's another pro tip: trust me. I see this all the time in my accounting practice. It's imperative to keep those business and personal finances separate. This is a surefire way to lose in an audit. I can't tell you how many times I've seen an IRS auditor tear apart a business taxpayer when they see this expense in what's called commingling situations. That's the fancy accounting term for when you mix your business and personal things together. If you don't listen to anything else I say today, please, please make sure you keep your business and personal records separate.

Ralph Estep Jr.:
08:49

Now let's look at the final tax cheat item today, and that's hiding money in offshore accounts. And I know a lot of this won't affect many people, but one of the biggest temptations for high-net-worth individuals is stashing money overseas in secret offshore accounts. This clearly violates the law requiring you to report all your income, no matter where it's located around the world. Did you know that question is even asked on those tax returns? And you are committing tax evasion if you fail to report that money in your return. Some people rationalize hiding money overseas to delay or evade taxes, but be warned: the IRS is cracking down hard on unreported foreign accounts and income. The penalties for getting caught are severe. So don't go down this unethical path.

Ralph Estep Jr.:
09:36

We've gone through some of the most common ways people creatively misrepresent things on their tax returns. Let's talk about how the IRS catches these tax evaders. The truth is, their technology and auditing capabilities are greater than they've ever been before. So here are some ways they uncover tax cheating: data mining; third-party documents like bank records to look for unreported income; they audit businesses in cash-heavy industries like restaurants and construction; they trace cryptocurrency transactions that may not have been reported. And here's one a lot of people don't know about: they're analyzing social media posts for clues that income was underreported. This one is huge. The IRS has a whole team of agents who review social media and look for those major purchases, and then take a look at your income being reported and see if it makes sense.

Ralph Estep Jr.:
10:27

Now I'll tell you a little story. I remember many years ago when I was working for another accounting firm. We had a client who was being audited. We'd scheduled a meeting with the IRS auditor at our office, and the client happened to arrive at the same time as the auditor. The client pulled up in his brand-new bright red Corvette and shared a quick glance with the auditor as they entered our office. At the time, I don't think he even realized that was the auditor. We started the discussion, and the first thing the auditor asked the client was, "Where did you get that sharp ride?" The client quickly replied without even thinking, "I paid cash for it. I got a great deal." The auditor nodded and replied, "That is a really nice car." But they wanted to understand where the cash came from since the client had only put in income of just under $30,000 on the return being audited. Bam, busted. You've got to think about what you're doing.

Ralph Estep Jr.:
11:18

Here are some other ways the IRS catches tax evaders: they use whistleblower reports from disgruntled employees or business partners. And here's a big one: they compare tax returns of suspected cheats year over year for discrepancies. The reality is, there aren't many places you can hide income today without the IRS finding out eventually. That's why honesty is always the best policy when filing taxes.

Ralph Estep Jr.:
11:40

So, you might ask, "Ralph, what happens if you're charged with tax evasion?" Okay, confession time: maybe you fudged some numbers on a past return or two. I think most people have been tempted to cheat at least a little on their taxes. But after hearing about the sneaky ways the IRS catches tax evaders, you're starting to feel nervous and you want to come clean. So, what happens if the IRS determines you intentionally misrepresented or concealed information on your tax returns? Let's talk through a few possible scenarios.

Ralph Estep Jr.:
12:12

Now, they may assess what's called civil penalties. On the less severe end, the IRS may simply assess additional taxes plus penalties and interest. If they discover an error, the penalty is generally 20 to 25% of the unpaid tax—not fun, but manageable. Just file an amended return and pay what you owe, pay the penalties and interest, and move along. But here's the problem: they could pursue criminal charges. For more egregious violations, especially if the IRS believes them to be willful or intentional, you could face criminal prosecution. Penalties for that can include massive fines of up to $250,000 and up to five years in prison for each charge. The IRS doesn't make deals with you like you see on crime shows. If you agree to pay back taxes, interest, and stiff penalties, you can still end up doing jail time for tax crimes.

Ralph Estep Jr.:
13:05

These situations could also lead to the loss of licenses. A lot of people don't think about that. If you are charged with tax evasion, you may also lose professional licensing required for your business or career. People like doctors, lawyers, accountants, CPAs like myself, contractors, real estate brokers, and more can have their licenses suspended if they're convicted of tax crimes. So basically, the consequences of intentional tax cheating can be life-changing, and not in a good way. Doing a little extra time behind bars and losing the ability to work in your profession is probably not worth shaving a few bucks off your tax bill.

Ralph Estep Jr.:
13:42

So, here's my thing for today: when in doubt, be conservative on those returns and make sure you can fully back up any deductions claimed. And if you need to amend past returns to correct errors, it's much better to get ahead of that than wait for the IRS to reach out to you.

Ralph Estep Jr.:
13:58

Okay, let's shift gears and talk about some positive steps you can take to avoid the temptation to cheat on your taxes. So here are my tips to file ethically and minimize your tax bill.

Ralph Estep Jr.:
14:07

Number one: I'll stress this and I'll stress this: keep meticulous records to support all of your income, all of your deductions, and anything else you claim on your tax return. Number two: consult a tax pro if you have a complex return or you're unsure how to report certain items ethically. Number three: contribute to retirement accounts to lower your taxable income. Number four: explore above-the-line tax deductions like mortgage interest and charitable giving; make sure you can back it up, and those sorts of things. Number five: invest in qualified opportunity zones for tax breaks on capital gains. We'll probably do a show on that in the future.

Ralph Estep Jr.:
14:45

Number six: talk to a tax strategist about legal ways to structure your business and personal finances to minimize taxes. It is perfectly legitimate and legal to minimize taxes. It is just not legal to evade taxes. I always say the goal is tax planning. Tax preparation is just an added effect of necessity, but the true value is found in tax planning. Number seven: stay up to date on changing tax laws and how they impact your specific situation. Number eight: consider meeting with a financial planner to develop a tax-savvy personal financial plan. Number nine: if you listen to my show, you know I talk about this all the time—building an emergency savings fund so you don't feel desperate to cut corners on your taxes. And number ten: and this one is vitally important—pray for wisdom and integrity as you handle your finances. God is faithful to guide us if we ask Him.

Ralph Estep Jr.:
15:42

Alright friends, well that wraps up for today. I know I covered a lot. If you take only one thing away today, let it be this: God calls us to honor the authorities He has placed over us, including the dreaded IRS. Pay your taxes properly, and when you sleep at night, you can rest easy knowing that you operate with integrity. Now head over to our website at AskRalphPodcast.com if you want to hire me to prepare your taxes or assist you with other tax and accounting questions, and while you're there, sign up for our email updates so you never miss an episode. If this discussion opened your eyes to any past tax mistakes, schedule a consultation with me and we'll discuss getting those issues corrected. The sooner you deal with it, the better.

Ralph Estep Jr.:
16:24

Also, please do me a favor: share this episode if you know someone who needed this tax chat as much as you did. Word of mouth is our best method of getting the Ask Ralph Podcast out there. The more people who need to master their finances from a faith perspective, the better. Well, that's all for today. Remember, if you have any questions for the show, go to our website and I will answer your questions as part of the show. That's what I love to do. I like to help people. I want to impact you in a positive way. So stay financially savvy out there and God bless you abundantly.