When it comes to tax advice, be careful whom you trust.
There is some remarkably bad and wrong and hazardous-to-your-health information out there that—despite being repeatedly debunked—just will not go away. Some of those ideas are clearly erroneous, but others can snag even very bright people.
Consider the case of Carter White Rae, a dentist in Michigan. He followed some bad advice and ended up with a bill from the government for over half a million dollars—plus a 45-month jail sentence. (More on his story below.)
Remember: You may be a logical person, but tax law is not always logical. Even if something makes sense to you—or sounds like it's the way the law should work—it may still be completely wrong. There's no substitute for investigating how the law does work.
This article guides you through some of the worst offenders—ideas that have landed taxpayers in major trouble. We want to stress up front that you should not, by any means, use any of the 10 tax protestor arguments you're about to hear.
The most dangerous tax strategies are the ones that lead you to believe you do not have to pay any tax at all. Known in IRS lingo as "tax protestor" arguments, they claim that by virtue of little-known quirks in the law or because of never-correctly-ratified amendments, you can somehow sidestep all U.S. tax requirements.
No matter how intricate those arguments can be, they all suffer from the same problem: The IRS and courts reject them. The government has already ruled against them, and if you use one of those arguments, the government will eventually catch up with you and demand its money. It's a question of when, not if.
It comes down to this: If you make a losing argument, you shouldn't expect to win.
Take It from the IRS
The IRS was nice enough to compile a list of arguments that it has heard before and will categorically reject:1
1. The filing of a tax return or the payment of federal income tax is voluntary.
2. Taxpayers can reduce their federal tax liability by filing a "zero return" that reports zero income and zero tax liability.
3. Compensation received for personal services isn't income.
4. Military retirement pay isn't income.
5. Only foreign-source income is taxable.
6. The IRS isn't a U.S. agency.
7. The taxpayer isn't a citizen and therefore isn't subject to federal income taxes.
8. The taxpayer isn't a "person" under the tax law and therefore isn't subject to federal income taxes.
9. Various constitutional amendments permit the taxpayer to avoid taxes.
10. Form 1040's instructions and regulations don't have an OMB control number as required by the federal Paperwork Reduction Act.
Penalties and Prison
The IRS believes that tax protestor claims are "frivolous" and will take no mercy on you if you rely on one to avoid paying taxes. The courts tend to agree and uphold those penalties—and sometimes impose prison time as well.
Whenever you "willfully attempt to evade or defeat" your taxes, you're looking at fines of up to $100,000 ($500,000 for corporations) and prison time of up to five years.2 That's on top of having to pay the taxes due, the prosecution's costs, and any other penalties.3
The tax code is not short on penalty provisions in this area. Here are a few other penalties you could face for understating your taxes or not timely filing your returns:
An "accuracy-related" penalty equal to 20 percent of your underpayment if your underpayment is due to negligence or disregard of the tax rules. (This penalty also applies—even without negligence—if your underpayment is more than the greater of 10 percent of the taxes actually owed or $5,000.)
Penalties of up to 25 percent of the taxes due for failing to file a return or pay taxes,6 depending on how late the filing or payment is.
Penalties of up to 75 percent for fraudulent failure to timely file an income tax return.7
A fraud penalty of 75 percent of your underpayment.8
A $5,000 penalty for frivolous returns or other submissions (for example, requests for hearings).9
A penalty of 20 percent of the excessive amount in an erroneous claim for a refund or credit.10
A $25,000 penalty for making frivolous arguments in tax court.11
Preparers pay too. Tax return preparers who get involved with frivolous arguments also risk penalties and possible imprisonment.12
How to Spot Bad Strategies
With tax law as complicated as it is, how are you supposed to tell the difference between a legitimate tax reduction strategy and a baseless idea that will get you in trouble?
The main problem with tax protestor arguments is that they claim to let you ignore the plain language of the law —simply by saying that the IRS isn't legitimate or that you aren't subject to the rules.
Real tax strategies work within the law, finding deductions or ways to reduce your income that the tax code or IRS have explicitly blessed—rather than going around the law or ignoring it.
When you read about a tax strategy, be sure that it focuses on how to keep the right records and that it cites tax law, regulations, or IRS guidance for support.
Down the Primrose Path
Carter White Rae is a dentist in Michigan who got snookered by bad tax advice. He filed federal and state tax returns every year—but instead of paying taxes with those returns, he wrote the government a long list of reasons why he didn't have to pay.13
Not surprisingly, the authorities disagreed with Rae's philosophical postulations. Various courts and government agencies told him again and again that his theories were legally incorrect. But Rae stuck to his guns.
By November 3, 2014, Rae owed a combined total of almost $550,000 in federal and state taxes. Eventually, he faced criminal charges for tax evasion14 and mail fraud.15 After a jury convicted him, the federal district court decided to add to the sentence called for under the U.S. Sentencing Guidelines because it found he used "sophisticated means" to hide his crimes.
The court ultimately sentenced Rae to 45 months in prison and ordered him to pay the federal and state tax authorities the taxes and penalties he owed. A court of appeals upheld the sentence.
Why the stiff sentence? Rae did more than just make bad arguments regarding his income taxes—he also committed outright fraud:
He operated his dental practice under the name and employer identification number (EIN) of the former owner.
He used that name and EIN to open a business bank account and credit card account for the practice. He used the business bank account, the dental practice credit card, cash, and money orders to pay the practice's expenses and his personal expenses.
He arranged to have insurance payments owed to him made payable instead to his patients, who would then pay him in cash.
In effect, Rae was asking the government to come get him, and that's exactly what happened.
There are some bad ideas and strategies floating around out there—including tax protestor arguments that claim that you don't have to pay any tax at all. But you can protect yourself by understanding which types of tax reduction strategies are legitimate and which are not.
Tax protestor arguments have lured even some very bright and successful businesspeople. But they will inevitably cost you in the end. The government thinks of these arguments as fraud and will come down on you with a hammer.
When you look for tax strategies, be sure to find ones that explain the types of deductions the law allows, describe the documentation you need to support your claims, and cite authorities like the tax code, regulations, or other IRS guidance.
There are a lot of great, legal ways to reduce your taxes. You won't always be able to cut your tax bill to zero—though that's possible—but you'll save money within the bounds of the law, which will keep you and your wallet safe.
Source: Bradford Tax Institute
1 IRS Publication, The Truth About Frivolous Tax Arguments, dated Feb. 2016, ps. 1-47.
2 IRC Section 72Ol.
4 IRC Section 6662.
5 IRC Section 6651(aXl).
6 IRC Section 6651(a)(2); 6654.
7 IRC Section 6651(f).
8 IRC Section 6663.
9 IRC Section 6702.
10 IRC Section 6676.
11 IRC Section 6673.
12 IRC Section 6694; 6700; 6701; 7206.
13 U.S. v Rae, 117 AFTR.2d 2016-1328 (6th Cir. 2016).
14 bid; IRC Section 7201.
15 18 U.S.C. Section 1341.