Understating expenses and an amended return

[AuditorTurnedGood]

I have a hypothetical question. If a self employed individual were attempting to attain a mortgage, and income verification was being performed by looking at business income, would it be a violation of tax law to file a return underclaiming expenses, thus overstating taxable income, paying in the tax, and then filing an amend to claim the correct deductions? Let's take the whole potential for mortgage fraud out of the picture and just look at taxes. My gut tells me this cannot be done, and if they wanted to do it, I couldn't sign off on the return due to Cir 230 rules and my knowing the return was inaccurate.

[Nashville]

One-Way Valve

I believe the only thing codified is a provision which minimizes a taxpayer's tax liability or payment status. Also some separately stated penalties for underestimation of gross income. My opinion is that this applies to EIC situations where deductions are ignored to keep a taxpayer from falling below the optimum EIC income bracket.

The circumstance of which you speak is certainly an ethical violation, but not so sure it is a tax code/reg violation.

[DaveO]

Filing of an inaccurate return

has to be a violation. When you sign the return under threat of perjury and you know that it's incomplete then you have at a minimum perjured yourself.

[OtisMozzetti]

Mortgage fraud appears to be disreputable conduct

Circular 230 says that it is disreputable conduct to be CONVICTED of any criminal offense involving dishonesty or breach of trust. It appears to me that knowingly preparing a tax return which exaggerates income could in some circumstances rise to the level of aiding in a fraud.

A second issue is that lawsuits against the client who fraudulently seeks the mortgage might name the tax preparer as a defendant. We have always made it hard to get any "income verification letter"; any such letter always hedged whatever it said by noting that it was based upon the information furnished by the tax client, and contained other disclaimers.

[myerstaxes]

I had a loan broker

email me to ask me to amend a return of a guy trying to get a loan...Some of the same issues as stated here, plus wanted to increase income...I sent him a very pointed response and ended it by saying..."When I worked for the IRS, we call what you wanted to to "FRAUD" "
I do not touch a return where someone is trying to fudge for any reason...

[Nashville]

No Argument

No argument with anyone that it may be disreputable or against some law, or may be aiding and abetting a fraud.

However, the question was whether it is against the tax laws to overstate income, and I'm not aware of any code/reg that is violated, except possibly overstating to achieve a higher EIC or some other kooky refundable credit.

[Uncle Sam]

Understating Expenses

Question: Would any of you be willing to sign your name to a statement where you've OVERSTATED income for the purposes of a client OBTAINING (not ATTAINING) a mortgage?
True - the tax authorities (IRS, State Tax Dep't) might not bother you -

But - wouldn't it bother you that when the client defaults on the mortgage - your name will be the very first to pop up in the mortgage broker's mind to chase after for overstating income?

[Bees Knees]

The other issue is self employment tax. It is against the law to overstate your Social Security earnings, which could result in increased Social Security benefits. That is why there is a Self-Employment Tax Optional Method (TTB page 5-24) that allows farmers and other low income taxpayers to pay into Social Security even though they show a loss or not enough Self Employment income to earn a Social Security credit for the year.

If it was not against the law to overstate your self employment income, then what is the purpose of the Self-Employment Tax Optional Method, and related rules? Without such a law, a self employed person could claim any fake amount of income, pay income tax and Social Security tax on the fake income, and qualify for Social Security benefits.

[Bees Knees]

Interesting report by the Office of The Inspector General on “The Social Security Administration’s processing of Internal Revenue Service Overstated Wage Referrals.”

http://www.ssa.gov/oig/ADOBEPDF/A-03-02-22068.pdf

The report said in part:

Each year, a number of taxpayers contact the IRS to dispute wages posted to their earnings record as well as the associated taxes. If the IRS concurs with the taxpayer, the IRS sends a referral to SSA stating the earnings reported under a specific Social Security number (SSN) do not belong to the person holding that SSN….

Our review of the 24 referrals already corrected by SSA revealed numerous cases of identity theft. In addition, after reviewing the 65 unprocessed referrals, we agreed with the IRS' conclusion that the wages do not belong to the owners of the SSNs. We estimate approximately 7,800 of the TY 1999 IRS referrals may relate to overstated wages not identified by SSA, causing the MEF to be overstated in TY 1999 by as much as $66 million. If we estimate total overstated wages related to the 80,000 unprocessed referrals, this overstatement in the MEF could total $438 million. These overstated wages, if left uncorrected, could lead to improper payments to future retired beneficiaries, totaling an estimated $41 million over the beneficiaries' lifetimes.

The point being, overstating self-employment earnings for whatever reason, whether it is due to identity theft, or mortgage fraud, or EIC fraud, leads to

improper payments to future retired beneficiaries.

If it were not against the law, the Inspector General would not have issued this report telling SSA to get off their hind end and processes all of the IRS referrals on overstated wages.

[Bees Knees]

Another interesting point is made on page SE-4 of the IRS 1040 instructions under "Optional Methods" for computing self employment tax when a taxpayer shows a loss or low income. The following benefits result from overstating your self employment earnings under the Optional Method:

• Qualifying for Social Security benefits or increasing these benefits
• Qualifying for EIC or increasing EIC
• Qualifying for the Additional Child Tax Credit or increasing the credit
• Qualifying for the Child and Dependent Care Credit or increasing the credit
• Qualifying for the Self Employed Health Insurance Dedution or increasing the deduction.

All of the above are allowed under the Optional Method for figuring Self Employment tax. The Optional Method, however, has limitations. You cannot just make up any amount of SE taxable income to qualify for any of the above benefits.

[Grumpy]

I found this

in some of my old files:


Rev. Rul. 56-407

The question has been presented whether taxpayers may disregard depreciation and other allowable deductions in computing net earnings from self-employment for self-employment tax purposes. Held , under section 1402(a) of the Self-Employment Contributions Act of 1954 (chapter 2, subtitle A, Internal Revenue Code of 1954), as amended, every taxpayer, with the exception of certain farm operators, must claim all of his allowable deductions, including depreciation, in computing his net earnings from self-employment for self-employment tax purposes. Held further , if a farm operator has gross income from farming of more than $1,800 and qualifies for and uses the optional method of computing his net earnings from self-employment, as provided in section 1402(a), he must first compute his actual net earnings from self-employment under section 1402(a) without regard to the optional provisions of that section. For purposes of that computation, the farm operator must claim all of his allowable deductions, including depreciation. If he has gross income from farming of not more than $1,800 and qualifies for and uses the optional method of computing his net earnings from self-employment, it will not be necessary to compute his actual net earnings and, therefore, he is not required to claim his allowable deductions.

This ruling also applies to members of certain partnerships with respect to taxable years ending on or after December 31, 1956, because they may also qualify as farm operators entitled to the optional method of computing net earnings from self-employment.

Section 208 of the Social Security Act, as amended, provides penalties for a person who makes may false statement or representation in connection with any matter arising under the Self-Employment Contributions Act of 1954, for the purpose of obtaining or increasing benefits under the Social Security Act.

[taxtime]

What do you think about this one?

I have a client who has a small construction business. He gets some 1099’s but he also does a lot of work in cash/checks with no receipts. Using just his 1099 income he could not survive. He gives me his cash sales numbers that seem reasonable to me. I try to get him to give receipts for all his work, but have not been able to get him to do that. I had a mortgage company call me about his returns. I was going to give them a letter that stated I prepared the returns based on the information provided by the client. Anything else I should do to cover myself? I think he is being honest because I have known him for 20 years, but you never know

[AuditorTurnedGood]

wow

Seems I’ve raised a contentious point. (sorry for the attaining vs. obtaining issue). I really wasn’t planning to do this return, but it seemed interesting to me that there didn’t appear to be anything in the code baring a non-professional from doing this (with the new CIR 230 rules, my ethical standards have gotten piano wire tight). I found the point on SE tax interesting, as well as the potential liability of the mortgage company found out. I think another good question was raised; how do we protect ourselves in these situations. The easy answer is “can the client” but what if the incorrect information is not obviously incorrect?

[veritas]

The best way to protect ourselves

is to not lie or cheat or help someone lie or cheat.

[taxtime]

I agree with you

I agree with you.