Fictitiously Overstating Taxable Income
Posted: 9 Mar 2021
Date Written: August 1, 2020
Income tax fraud is a frequent topic of law review articles. However, except for targeted looks at certain tax provisions, their focus – as well as that of the IRS, DOJ and court cases – is nearly exclusively on the more typical cases of income understatement of taxable income. This Article details and contrasts the wide range of settings in which a taxpayer is motivated to fictitiously overstate taxable income. Understanding these different settings helps answer critical questions related to the overstating, such as which taxpayer is doing the overstating? why are they doing it? for what years are they doing it? and how is it being accomplished?
This Article details different reasons taxpayers overstate income for tax saving purposes. One approach is to report income that never exists, so as to take advantage of negative marginal tax rates or to become eligible for a particular tax standing that does not apply at a lower income level. The second approach is used with income that at some point (or for some taxpayer) will exist; it is just that the taxpayer overstates it in the wrong year (or for the wrong taxpayer). A reason to do so is to shift income to a lower marginal tax rate.
However, this Article also details how taxpayer engage in overstating taxable income not to save taxes; indeed, it often raises tax costs. This is when taxable income is overstated as a conforming side-effect of activity not related to taxes, such as overstating income on loan applications or other financial statements.
The purpose of this Article is not merely to catalog interesting cases of how the complicated Internal Revenue Code leads to perverse results such that overstating taxable income can actually reduce taxes or to shine a light on scams in non-tax settings that use fictitious tax returns as a tool. Instead, the detailed examples are offered as a roadmap to government, counsel and others tasked with analyzing such settings.
This Article ends by detailing considerations in applying the Code’s tax crime provisions to the various types of fictitious overstatement settings. The wrongdoers’ goals and methods of overstating can be subtly different and are relevant to government investigations, as well as to which Code crime provision(s) apply and government’s ability to prove the requisite state of mind in tax prosecutions (and even in non-tax prosecutions where tax filings are relevant).
Keywords: tax crime, tax fraud, negative marginal tax rate
JEL Classification: K34, K14, K42
Suggested Citation: Suggested Citation