As the calendar flipped over to 2018, the frenzy of prepaying property tax is finally over. As I observed in emails and Internet postings it occurred to me there are two opposite camps when it comes to paying taxes.
The first camp, where I belong, goes by the book. They research the issues and they go by what the rules say. The second camp also researches the issues but they take calculated risks. They ask what are the chances they will get caught if they don’t go by the book and what the possible downside would be if they do get caught. They’re basically saying “Catch me.”
Even after the IRS published the advisory telling people that prepayments of property taxes not yet assessed are not deductible in 2017, someone asked:
If I deduct the payments for 2018 property taxes even though they haven’t been assessed, what are the chances I’ll be audited? And if I am audited and the deductions are not allowed, what will the consequences be?
The answer is they probably won’t be audited. Even if they are audited, they will just play dumb and say their local government was accepting prepayments and they thought it was deductible if they paid in 2017. When you have plausible deniability, the penalty is usually just the taxes owed plus interest. If they go by this approach item after item, year after year, even if they lose sometimes, they will probably still gain way more than they lose over time. The “catch me” approach “works.”
When you ask them why they would go against explicit rules, they say the IRS rules aren’t necessarily the final words and the rules can be challenged in court, even though they never really challenge the rules themselves. This way they justify to themselves it’s OK to ignore the rules. They won’t blatantly make up numbers on their tax return but they are willing to “not know” some rules when “not knowing” goes in their favor.
Apparently enough people want to make up their own rules that it has become a running joke in the tax professionals circles, as evidenced by this tweet from a tax lawyer:
— Kelly Phillips Erb (@taxgirl) December 29, 2017
Our tax system is in a way an honor system. The IRS publishes rules and they expect everyone to follow those rules. You are not required to submit evidence to support every number on your tax return. The enforcement is by the possibility of an audit, but everyone knows the rate of audits is very low. Most people have never been audited. When you are audited you are not audited for all the years. If someone is willing to take calculated risks, there’s a lot of room to do so.
For example, you are allowed to contribute to an HSA and take a tax deduction only when you are in an HSA-eligible high deductible health plan. But you are not required to show any proof you are indeed in a high deductible health plan. How do they know what type of health plan you were in? They don’t. Some high deductible health plans aren’t HSA-eligible. How do they know your plan wasn’t eligible even though it had a high deductible? They don’t. You aren’t eligible to contribute to an HSA when your spouse contributes to a general-purpose health care FSA. How do they know your spouse had an FSA? They don’t. Would you get audited only because you contributed to an HSA? Probably not, when millions of others also legitimately contribute to an HSA.
Another example. When you had a wash sale you are supposed to exclude the loss. If you did it in the same brokerage account, the brokerage account will flag it as a wash sale. If you did it across two accounts at two different firms, neither firm knows to flag it. If you just take the loss, how do they know you had a wash sale? They don’t. Would you get audited only because you took a loss? Probably not, when millions of others also legitimately took a loss.
Opportunities like these for “not knowing” the rules are numerous. I would never take them myself. That’s not right, no matter what justifications people make up for their own conscience, or how likely and profitable they would get away with it. However, some people see it as a situation of offer and counter-offer, as in “I make an offer to pay this amount. If you don’t come back with a counter-offer that means you accepted my offer.”
It comes down to our attitude toward taxes. There’s a weird culture in that money paid in taxes is seen as just wasted. People feel good about donating to charities while justifying super-aggressive or downright illegal moves to lower their taxes.
It’s especially ironic against a backdrop of a controversial new tax law. The day before, some people were vehemently against the new tax law saying it will add a huge amount to the deficit and it will take away the necessary revenue for the social safety net. The day after, some of the same people were lining up at the local tax offices prepaying their 2018 property tax and thus adding even more to the deficit and depriving even more revenue from the social safety net. Some engage in mental gymnastics in finding excuses against the explicit notice from the IRS, telling themselves it’s not all black and white. Even elected officials who supposedly care about the social safety net went out of their way in their official capacity to make sure the revenue for the social safety net is deprived some more.
I’m firmly in the camp of doing it by the book and not pushing the envelope on your taxes. It would be very sad to say “I’m able to retire because I made up my own tax rules and they never questioned me.” or “I built my wealth on the backs of the elderly and the poor.” Save money by other means. Your financial success does not depend on your ability to pay the least amount of taxes you can get away with. If that means I pay more taxes than otherwise, I don’t see the taxes I paid as wasted. I see it as supporting the necessary social safety net and social services. Paying lower taxes isn’t always a worthy pursuit.