Recent changes in the tax laws eliminating or curtailing some long-time deductions and credits could turn ordinary taxpayers into inadvertent tax cheats if they are not careful.
"Tax law is so complex nowadays, you often don't know what you don't know," New Jersey tax attorney Brad Paladini said in an interview with CNBC's "American Greed."
The term "tax cheat" brings to mind infamous felons like Al Capone, whose decade-long reign of murder and mayhem ended in 1931 only after the feds managed to prove he evaded $250,000 in taxes. Or New York hotelier Leona Helmsley, who once famously declared that "only the little people pay taxes," only to wind up in prison for failing to pay hers. Or even MTV "Jersey Shore" star Mike "The Situation" Sorrentino, accused of failing to report millions of dollars in income for things like product endorsements and personal appearances. For Sorrentino, flouting the tax law was no accident.
"In 2011, I can tell you that he did not file a tax return at all," IRS special agent Cheryl Matejicka told "American Greed."
Sorrentino recently completed an eight-month federal prison sentence after pleading guilty in 2018 to a single count of tax evasion. He paid a $10,000 fine and $123,000 in restitution.
Of course, the same laws and penalties that ensnared Sorrentino and others also apply to everyone else, which is why Paladini believes most taxpayers should not try to do their taxes on their own.
"My best piece of advice is to find a good CPA to help you prepare the tax return. Don't try to prepare it yourself," he said.
And make sure it is someone who is not a pushover when it comes to deductions and tax-avoidance strategies.
"You've got to find somebody who's willing to tell you, 'no'," he said.
The recent changes include the Tax Cuts and Jobs Act — the biggest overhaul of the tax code in more than 30 years — which went into effect in 2018. Among the side effects of the new law were drastic changes in the refunds for millions of taxpayers last year, prompting many to adjust their withholding for 2019. Now, the IRS is urging those taxpayers — and everyone else — to revisit their withholding even if they recently did so. The agency offers an online tool to help you calibrate your withholding.
"A Paycheck Checkup can help you see if you're withholding the right amount of tax from your paycheck. Too little could mean an unexpected tax bill or penalty," the IRS website warns.
In exchange for tax cuts on individuals and corporations, the law eliminated some popular tax breaks. Gone is the personal exemption of $4,050 per person. Also gone: deductions for moving expenses, and for most employee business expenses including the home-office deduction. Theft and casualty losses are no longer deductible unless they are the result of a disaster declared by the president. The law also got rid of the deduction for interest on most home equity debt.
You can still take a deduction for mortgage interest, but for loans taken out after December 2017 the deduction is limited to the interest on $750,000 in debt. And in one of its most controversial features, the law caps the deduction for state and local taxes at $10,000.
Taxpayers can avoid the uncertainty about what is and is not deductible — and possibly save time and money — by taking the standard deduction instead of itemizing their deductions. For the 2019 tax year, the standard deduction rises to $12,200 for an individual taxpayer, or $24,400 for a married couple filing jointly. But Paladini noted that for some people, taking the standard deduction could mean leaving some money on the table.
"If you, let's say, own a big home and pay a lot of interest on it, that would be someone who would benefit from itemizing your deductions," he said. "If you have a lot of medical expenses as well, you may benefit from, from itemizing."
Lawmakers saw the increased standard deduction as a way to simplify the tax code, since fewer taxpayers would need to go to the trouble of itemizing. But for many taxpayers, the change means they must calculate their taxes both ways, while taking care not to become an inadvertent tax cheat by claiming deductions that are no longer allowed.
In many cases, a perfectly legitimate federal tax strategy can put you at odds with your state's laws. One example is health care.
The new federal tax law effectively ended the individual mandate under the Affordable Care Act by eliminating the tax penalty for those who go without health insurance. But in response, several states have passed individual mandates of their own with penalties that can be as high as the cost of insurance coverage. In New Jersey and the District of Columbia, the mandates went into effect in 2019. In California, Rhode Island and Vermont, they took effect this year. They join Massachusetts, which has had an individual mandate since 2007. Other states could follow.
A more recent change involves 529 college savings plans, which allow parents to invest money toward their children's education, then withdraw the proceeds tax-free for qualified expenses such as tuition and room and board.
A provision in the Secure Act, the retirement savings law passed by Congress late last year, for the first time allows tax-free withdrawals from 529 plans to pay down student loans. But most states have not yet followed suit, which means you could take out money that is free of federal taxes, only to get hit with a state tax penalty. Paladini said it may make sense to wait to use 529 money for student loan payments until the state tax implications become clearer.
"Oftentimes it takes state legislatures a year or two to kind of catch up with the federal, but a lot of the times they will implement what's done on the federal side. So, if you give it time, maybe a year or two, you could get the state benefit as well," he said.
Another area where taxpayers can get into trouble involves dependents. The new tax law cracked down on parents who shelter investment income from taxes by putting it into their children's names. Now, a child's unearned income above certain levels may be taxed at the highest marginal rate — 37% — even if the parents' tax bracket is lower. The Secure Act provided some relief from this change if certain conditions apply. Consult your tax professional.
Another potential parent trap is the Earned Income Tax Credit, which is supposed to provide relief for lower- and middle-income taxpayers.
For 2019, the EITC tops out at $6,557 for a taxpayer with three or more dependents who earns less than $50,162 per year ($55,952 for a married couple filing jointly). But because the amount of the credit is tied to the taxpayer's income and number of dependents, Paladini said it is ripe for abuse.
"What happens is, somebody will go to an unscrupulous tax preparer and that tax preparer will basically try to game the system," he said. "So, if you're not making enough money, they will basically put phantom income on your return to make it look like you're making more money than you really are to try to maximize that credit. Or, if you are making too much money, they will perhaps leave off some of the income, again to try to maximize the credit."
Some preparers will even falsify dependents in order to maximize the credits. Paladini warned that the IRS looks closely at year-to-year changes in dependents.
"The IRS will kind of say, 'That seems weird that this person was claimed for one year and no other year,' or it's a different last name or whatever reason they have to kind of suspect it," he said.
If you are planning to claim the EITC, do not fudge the numbers. And if you are using a paid preparer, make certain he or she signs the return, so you are not left holding the bag for any discrepancies.
"Oftentimes what they will do is, they will stamp the return as 'self-prepared,' making it look to the IRS like you actually prepared the tax return, when, in fact, you went to a professional to have it prepared for you," Paladini said.
If you have a side hustle or are taking part in the gig economy, you may get paid in cash. That means your customers may not provide you with a tax form such as a W-2 or a 1099. But do not let that tempt you to hide that income. You most likely still owe taxes, and the IRS has ways of finding out about it.
"A lot of people try to under-report their cash receipts, but it's definitely something that the IRS is on the lookout for," Paladini said.
He advises keeping accurate records of all of your income and expenses. That way, you can report them accurately to the IRS, and you will have documentation in case of any disputes. What little you can shave off of your tax bill by fudging or cheating is hardly worth the cost of a Mike Sorrentino-style situation.
See how Mike "The Situation" Sorrentino got himself into a nasty predicament and traded the "Jersey Shore" for a federal prison cell. Catch an ALL NEW episode of "American Greed," Monday, Feb. 17 at 10 pm ET/PT only on CNBC.
Correction: A previous version did not include some provisions of the 2019 Secure Act that altered the 2017 tax reforms. The 2019 law eliminates an increase in the limit for medical expenses, which were to become deductible only to the extent they exceed 10% of adjusted gross income. For 2019, the limit remains at 7.5%. The act also eased provisions designed to crack down on parents shifting income to their children to be taxed at lower rates.