(This is Part 1 of a five-part series. Read Part 2, "Homeowners get good tax news for 2007"; Part 3, "How to deduct mortgage interest, points on taxes"; Part 4, "Home sellers keep profits, avoid taxes"; and Part 5, "Understanding Starker exchange rules.")
"The income tax created more criminals than any other single act of government." –Sen. Barry Goldwater (R-Ariz.)
Every year at this time, I write a series of tax-related columns. My purpose is to provide some guidance for homeowners preparing to file their income tax return. Normally, millions of Americans try to file their returns well in advance of the April 15 deadline. They either want an early refund if they have overpaid their tax or just want to get this burden off their back as soon as possible.
However, Congress in late December threw a monkey wrench at the Internal Revenue Service, by enacting a "patch" affecting the Alternative Minimum Tax, or AMT. According to the IRS, "as many as 13.5 million taxpayers using five forms related to the AMT legislation will have to wait to file tax returns until the IRS completes the reprogramming of its systems for the new law."
The five forms, which were not available for filing until Feb. 11, 2008, include: Form 8863 — Education Credits; Form 5695 — Residential Energy Credits; Schedule 2, Form 1041A, Child and Dependent Care expenses; Form 8396 — Mortgage Interest Credit; and Form 8859 — District of Columbia First-Time Homebuyer Credit.
Because most homeowners have mortgages and want to properly deduct the mortgage interest they pay, they likely had to wait until at least mid-February to obtain the proper forms and file their tax returns.
While researching the AMT issues, I ran across an interesting report just issued by the IRS, entitled "The Truth About Frivolous Tax Arguments." So while we all have some time on our hands, here’s a summary of what that 67-page report has to say about some of the arguments made by people who claim they don’t have to pay any income tax, including the IRS’s responses:
1. Filing of a tax return is voluntary. This argument stems from the IRS Form 1040 instruction book, which states that the tax system is voluntary. Proponents of this argument also rely on a 1960 U.S. Supreme Court case (Flora v. U.S.) where the high court wrote that "our system of taxation is based upon voluntary assessment and payment, not upon distraint."
But the word "voluntary" does not mean that income earners do not have to pay tax on their income. Rather, it means that taxpayers are initially allowed to voluntarily determine the amount of tax they owe without having the government make that determination.
Perhaps the IRS should drop the use of the word "voluntary," since its definition is a bit of a stretch. However, Mr. Royal Lamarr Hardy was sentenced in 2005 to a 156-month prison term for selling a tax evasion scheme called the "Reliance Defense" that claimed that the income tax was voluntary. The IRS report lists several more cases involving the "voluntary" argument.
2. The IRS must prepare federal tax returns for a taxpayer who fails to file. Would this be true? There’d be no more accountant fees, and many software computer programmers would be out of business.
This position is erroneously based on a provision of the Tax Code (Section 6020) that allows the IRS to determine the tax liability of a taxpayer and to prepare a tax return for persons who do not file or who file a false return. Supporters of this position argue that this gives them the right not to file and that the IRS will do it for them, without penalty.
The IRS has won numerous court cases in this area. According to one judge, in upholding the taxpayer’s conviction for willfully and knowingly failing to file a tax return, "… the purpose of section 6020(b) is to provide the Internal Revenue Service with a mechanism for assessing the civil liability of a taxpayer who has failed to fulfill his statutory obligation to file a return, and does not supplant the taxpayer’s original obligation to file established (by law). (U.S. v. Lacy, 5th Cir.1981).
3. Only foreign-source income is taxable. Here is yet another creative, but erroneous, assumption. Those who support this position claim that federal income taxes are excise taxes imposed only on nonresident aliens and foreign corporations for the privilege of receiving income from sources within the United States.
The IRS wants the American taxpayer to understand that this is completely false. According to the IRS report, in the year 2005 alone, several convictions were obtained against persons who promoted and preached this position.
4. The "United States" consists only of the District of Columbia, federal territories and federal enclaves. For those of us who live in the District of Columbia, this argument adds insult to injury. The motto on the D.C. license plate is "taxation without representation." Proponents of this argument take the position that such places as the District of Columbia, Guam, Puerto Rico and all of the Indian reservations are the only places where the income tax is applicable.
To ensure that this argument will not prevail, the IRS has brought numerous criminal court cases against those who support this position. For example, according to the IRS report, "in May 2005, a federal district judge sentenced Wayne C. Bentson to a four-year prison term to be followed by three years of probation, as well as requiring Mr. Bentson to pay restitution of over $1.1 million for falsely advising clients … that the Internal Revenue laws only applied to individuals residing in the Virgin Islands, Guam and Puerto Rico."
5. African Americans and Native Americans can claim a special tax credit as reparations for slavery and other oppressive treatment. This is a topic often debated in the halls of Congress. But unless and until legislation is enacted to provide reparations, it is not the law.
In August of last year, a federal court in Georgia issued a permanent injunction against Derrick Sanders, who promoted a tax fraud scheme claiming that the Yamassee group was a Native American Indian tribe whose members are exempt from paying any tax.
The Tax Court in 2006 rejected a similar argument that Mr. George was an Indian and thus not subject to our tax laws. According to the Court, Native Americans are subject to the same federal income tax laws as are other United States citizens, unless there is an exemption created by treaty or statute.
There are also a number of frivolous arguments based on constitutional grounds:
6. Taxpayers can refuse to pay income taxes on religious or moral grounds by invoking the First Amendment. If this were true, none of us would have to pay any income tax at all. The First Amendment provides all Americans the right to freedom of speech and press, to peaceably assemble without fear of government inference, and to practice the religion of our choice.
It does not, however, give us the right to refuse to pay income tax on the money we earn.
7. The income tax constitutes a "taking" of property without due process of law, violating the Fifth Amendment. This amendment protects persons from being "deprived of life, liberty or property, without due process of law …"
The Internal Revenue Code provides all taxpayers with ample due process, including the right to go to the United State Tax Court to challenge a deficiency asserted by the IRS, even before paying the contested tax.
8. Taxpayers do not have to file returns or provide financial information because of the self-incrimination found in the Fifth Amendment: "I refuse to give my Social Security number and tell the IRS how much money I made, because this information may incriminate me."
This is a creative, but baseless, argument. Numerous courts have thrown out this claim, based on an old United States Supreme Court case. In United States v. Sullivan, the court stated that the taxpayer "could not draw a conjurer’s circle around the whole matter by his own declaration that to write any word upon the government blank would bring him into danger of the law."
Despite this clear statement, the IRS continues to warn taxpayers that this argument will not prevail.
Indeed, all of these arguments — and more — continue to crop up on a yearly basis. The IRS issues this stern warning: "the Service will challenge the claims of individuals who improperly attempt to avoid or evade their federal tax liability."
The penalty for filing frivolous returns was increased in 2006 from $500 to $5,000. If in the opinion of the IRS any portion of a tax return is based on frivolous arguments, the IRS has the authority to impose this fine. "Too-good-to-be-true schemes are exactly that — too good to be true," said IRS Chief Counsel Donald Korb. "Taxpayers should be careful in making frivolous arguments," Korb added, "since courts have routinely rejected them."
Next week: a primer on real estate deductions.
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.
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