I Used to Be a Lawyer for the IRS. Here Are the 7 Big Ways Regular People Get in Trouble on Their Taxes

Even though tax season is over for some, we found this great article from INC Magazine written by a former government tax lawyer citing the seven things one should never, ever do with regard to their taxes. He refers to regular people which we assume includes small business owners as well as individuals and families. When someone with this much inside knowledge clues us all in, it’s important that we listen. So… read on, and heed his warning for the coming year.

FROM INC MAGAZINE / BY BILL MURPHY JR.

“I had a great day today: I got a letter from the IRS!' said nobody, ever, in the entire history of the United States.”

Long before I was a professional writer, I was a government tax lawyer. I worked for years as a trial attorney for the U.S. Department of Justice, Tax Division in Washington, D.C., and then in the general counsel's office for the Internal Revenue Service in several cities. 

Was it the best career fit for me? Well, let's just say that if I had the chance to do things over, I'd follow a different path. Still, as my mom likes to say, no education is ever wasted.

One of the big, practical things I learned during my time with the feds was just how easy it can be for good people to wind up in big trouble with their taxes.

I reached out to a former colleague, Gary Slavett, who is now a partner in the tax law firm Holtz, Slavett, and Drabkin in Los Angeles.

With Gary's help, here are the top seven, all-too-common mistakes that get regular people into heaps of trouble with Uncle Sam and the taxman.

1. They ignore official letters from the government.

It's an anxiety-inducing experience to get any kind of communication with an IRS return address--especially if you open it and see the government is suggesting you might owe more money than you thought. I've had the experience myself, and even though I've practiced law in the past, and even though we worked it out in the end, it wasn't fun.

However, bad news like this never gets better with age. It's best to dive into it immediately, call the IRS, talk to your accountant if you have one, and get on top it as fast as possible.

"Yes!" Slavett exclaimed, when I suggested this one. "Especially notices that come by certified mail. People sometimes put their heads in the sand, but many IRS notices give taxpayers a limited time to respond before an adjustment becomes final. If you miss the deadline, it can become much more difficult to fix."

2. They don't file returns when they're required to.

A surprising number of people simply don't file tax returns; maybe 5 percent of those who are required to. Moreover, people who fail to file one year's return often fail to file in later years, on the misguided hope that the IRS will just forget about them.

Spoiler alert: They almost certainly won't forget about you. Also, failure to file can technially be a misdemeanor criminal offense. The government won't likely go after someone who fails to file a limited number of returns -- especially if it's because of all-too-human failngs, like bad record-keeping, even substance abuse or other issues. But it's not impossible.

One big reason people don't file is that they think they can't afford to pay what they owe.

"But you should file even if you can't pay," Slavett reminded me, "because the penalty for late filing is 5 percent per month up to 25 percent. Compare that to the penalty for late payment, which is only half a percent per month.

3. They don't designate what tax they're paying.

This one is a bit advanced, but iif you get into the unenviable position of being behind on your taxes, you want to pay the most recent taxes first.

The reason is that there is a statute of limitations that kicks in--it varies, and I don't want to get too into the weeds here--but there are points in time when it's simply too late for the government to collect.

However, if you simply write a check to the U.S. Treasury without saying what tax you're paying, courts have held that the IRS can credit it to the oldest account--the one that would have become uncollectible soonest. 

4. They don't pay their employees' trust-fund taxes.

This one can be a huge issue for small businesses.

You probably know that as an employer, you're obligated to pay taxes on behalf of your employees. But sometimes, when business owners are facing cash-flow issues, they will ill-advisedly skip payments, thinking they can make them up later.

This is super-dangerous, because if the business fails anyway, the IRS can go after the decision makers within the company who decided not to pay the taxes, and try to collect them personally.

"Further," Slavett reminded me, "for those that continue to fail to pay employment taxes, the IRS may bring criminal charges."

5. They play fast and loose with the facts, especially when the IRS is watching closely.

I hope it goes without saying--although having had some experience in these cases, I know it doesn't--but don't lie to the government when it's investigating you. 

Not only does it open you up to much greater legal jeopardy if you get caught, but government investigators are people like anyone else. So, whatever discretion or breaks they might be able to offer in your favor are likely to evaporate if they discover you're trying to put one over on them.

"If audited, never lie to the auditor, and never create fake documents," Slavett said. "This is one of the worst things you can do. This can turn a civil case that is about money into a criminal case that is about prison. To me, this might be the most important one on your list."

6. They fail to report foreign bank accounts and income.

The U.S. stands almost alone among the world's countries in that our citizens are required to report foreign assets and income, and to pay taxes even on income they receive from foreign sources.

It's a controversial stand, but at least for now, it's still the law. Moreover, it's become more of a focus for the IRS in recent years--tracking down unreported foreign income and property. 

"If you have foreign financial accounts, be sure to report them as required on your tax return. Failure to do so can result in very large penalties," Slavett said.

7. They don't keep good records (or keep them long enough). 

The general rule is that the IRS can only audit going back three tax years.

But, there are some circumstances where they can go beyond that, and so some tax experts will advise you to keep records for at least six years.

However, even that doesn't settle the issue. For example, if you purchase a sizable asset like a house, you want to keep the records relating to the sale as long as you own the asset itself.

One common reason: when you go to sell it, you might need to prove what you paid for it in order to calculate taxes owed.

Maybe you can reconstruct the data that you need. But that may not be as easy as you imagine, and who wants to add that level of stress if it does become an issue?

One last bit of advice: in almost all circumstances, you can get an extension of the deadline until October 16 by submitting an IRS Form 4868 -- a very short form by the April tax deadline.

Just remember to do two things: File the extension form, and bookmark this article. You might want to check back in six months.