Thursday, July 23, 2009

New Tax Scams

In my 18 years of tax law practice, I have seen a number of tax scams. Most of the time, people try to hide assets, or under report income so their tax liability will appear lower. It is fairly common. Illegal, of course, but common nonetheless. But, I recently heard of a tax scam that seems rather creative in its fraud.

(Remember that this is highly illegal, and punishable by hefty jail sentences.)

Rather than under reporting income, some self-employed individuals are actually over reporting their income. Now, what is the benefit of doing this? They get to claim the maximum Social Security payments without paying into the system.

This scam only works for self-employed individuals. You see the Schedule SE is the self-employed person’s record of Social Security taxes you paid out. So, if you under report your income, your Social Security benefits get under reported as well. Meaning when you finally retire, your benefits will be greatly reduced.

Now, here is where the tax scammers found their loophole. The way the law is written, to get the highest amount of Social Security benefits, you must report 40 quarters (or 10 years) wherein you owed the maximum Social Security taxes. You only have to owe that amount, nothing in the law says you must pay that amount.

Therefore, if a self-employed person reports that they owe the maximum Social Security tax for 10 years straight, they need only avoid IRS collections until the liability runs out. Those who successfully run this scam avoid collections by not having bank accounts, not having assets, and running their business on a strictly cash basis.

With all the work and inconvenience in the scam, you are probably wondering how much this actually pays. The maximum Social Security benefit is $2,323 a month. So, collect that for 20 years, and you’re looking at hundreds of thousands of dollars.

Now, my purpose for writing about this scam is not to help you defraud the government. (I repeat, this is highly illegal. Do not do this!) Instead, this just illustrates how much effort some people will put into fraudulent schemes, while so many others refuse to put half the time into legally reducing their tax liability by increasing their tax knowledge.

(Hat tip to fellow tax blogger: Anthony Parent.

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